SME finance pounds
SME finance - UK banks want to lend, but do enough small firms want to borrow? (Reuters)

Banks aren't lending any more, goes the cry, as if it's some kind of deliberate plan by those devious bankers. I don't agree.

To try to address this claimed lack of lending, the 81% government-owned Royal Bank of Scotland has launched an independent review of its lending practices. The hope - accompanied by a suitably headline-grabbing figure - is that this will free up £20bn more for SME lending.

The popular claim contains some but not all of the truth. Banks are lending. That is how they make their money, and they are desperate to lend more. A more accurate version is that banks aren't making risky loans, and if we cast our minds back as far as 2007 we might remember that that is not such a bad thing.

But freeing up large sums of money for lending may not be the silver bullet people expect. We have seen schemes designed to free up more money fail to convert into more small business lending.

The real reason for the shortage of lending is that banks are not getting the volume of quality applications they need, and this needs to be addressed just as urgently as freeing up the money. No amount of spare cash would encourage banks to lend to someone they don't think will pay it back. More available funding is always a good thing, but will only convert into lending if we are also taking measures to ensure there are suitable businesses to lend it to.

The fact that banks aren't getting enough quality propositions doesn't mean there aren't good businesses to lend to. There are plenty. But many are not applying to banks because they think banks aren't lending or because the bank has made it too complicated to do so. Others may have approached the wrong person in the wrong bank or, despite having a great idea, produced a business plan that didn't meet the bank's criteria.

So, banks have billions of pounds to lend. What can they do to ensure they start finding these backable businesses?

Set your criteria

Firstly, banks need to be clearer about who they want to lend to. They should clearly articulate at what level they will lend, and in what circumstances. They should also make clear which sectors they will work with - perhaps they should have an equivalent of investment bank sector analysts to advise on good investments? This would help clear some of the mystery which currently surrounds some bank decisions, and reduce the number of disheartening applications that were likely to fail from the start.

Secondly they need to work more closely with customers to understand their businesses, the risks and opportunities. For example they could work alongside designated business mentors, this would enable them to better understand their customer's business and stay in touch with that business after the funds have gone in. This should encourage better applications, and therefore more lending.

So when Sir Andrew Large delivers his review of RBS, let's hope he goes beyond throwing money at the problem and provides some useful recommendations about how banks and business can work together to reach better funding decisions. That way we can make the whole lending process better for everyone, rather than generate more money that banks find it difficult to lend.

Nick Montague is chief executive of FundingStore, which creates an independent bridge between businesses, funders and advisers