CBILS, businesses, and moral hazard…

In recent days a debate has emerged about the extent to which the UK Government should underwrite loans to private businesses as part of the coronavirus business interruption loan scheme (CBILS).

On the one hand, the UK Government has opted to stand behind 80% of the value of the loan.

On the other hand, former Chancellor George Osborne, as well as Labour’s shadow Business Secretary Ed Miliband and others, have argued that the UK should stand behind the full 100% in at least some cases.

In other words, if the loan is not repaid by the business, the UK Government’s position is that it should only be liable for 80% of the value of that loan, while others argue that they should accept 100% liability.

Germany started off in a similar position and has made the switch to 100%. Making the suggestion this week that EU State Aid rules are a barrier somewhat puzzling.

The core economic principal involved here is a simple one: moral hazard.

Moral hazard in this context refers to how the behaviour of individual firms (including banks) might change when insured against losses stemming from their actions.

For instance might they take more risks, or behave less prudently, knowing that the state is liable for loans that are not repaid?

Concerns of this nature partly explain why there was an initial demand from some banks that businesses provided collateral against these loans.

Few doubt that some amount of the support that the UK Government are presently offering to businesses will be received by businesses which do not have a long term future.

As the support is withdrawn and firms are left to stand on their own two feet, it is expected that a number of firms will cease to trade and their outstanding liabilities offset by whatever residual assets they have. At 100% state liability the Government (i.e. taxpayers) absorbs all losses.

Moral hazard emerges with respect to the banks themselves as well. Concerns exist that 100% state liability may lessen scrutiny by lenders of those businesses they are extending loans to. Insured against all losses from these loans, might they take more risk?

Some worry that absent some wider ‘skin in the game’ either from the banks themselves or from security on other assets provided by the firms, the likelihood of firms taking the support now, and folding up without repaying in the future, is higher. How much higher is up for debate.

Against this, others argue that the advantage of the state assuming 100% liability is that it is easier for banks to lend, and to get money out the door to businesses (and in turn other businesses struggling for cashflow as well as individuals).

In the case of smaller loans where the volume is higher a change to 100% liability might make a significant difference to the volume of loans issued.

Against this backdrop is increased scrutiny of Ministers on the extent to which firms are receiving support through CBILS. Reports suggest that around 6,000 loans have been issued totalling just over £1bn. With concern about the number of businesses getting support being too low, the arguments to move to 100% state backing amplify.

This week a compromise was suggested at the Treasury Select Committee which would extend support to 100% up to £25,000.

This may be seen as a sensible compromise.

However the state is extending the hand of support on behalf of taxpayers, just as we saw in the aftermath of the financial crisis, and taxpayers will rightly want to make sure that the Government is spending their money wisely in choosing how to support businesses.

Repaying the money that the UK Government has spent to support the economy during the present crisis will have to be recouped in the future from additional taxes on businesses and individual taxpayers and/or through reductions in government spending.

So while it is important to get money out the door, a rush to do this without proper safeguards and scrutiny of who this support is being extended to, and limits on the liability assumed, creates a problem that taxpayers will be required to solve down the line.


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The Fraser of Allander Institute (FAI) is a leading economy research institute based in the Department of Economics at the University of Strathclyde, Glasgow.