English Commercial Banks and Organizational Inertia: The Financing of SMEs, 1944–1960

This article is a study in the strength of shared strategic beliefs amongst leading British clearing bankers in the years following World War II and how those common beliefs may have inhibited potential for market growth. The subject of the study is the performance of large British deposit banks with respect to the financing of industry. This behavior has long been criticized by economic historians as suboptimal and, depending on the commentator, has been presented variously as evidence of entrepreneurial failure, the gentrification of the City, social schism amongst the economic and social elite, the political influence of City institutions, the external orientation of capital markets, or institutional sclerosis.¹ However, in earlier studies we have offered a rational economic explanation of the banks' behavior and practices in the late nineteenth and early twentieth centuries.² We argue that firms adopted a type of "transaction bank" approach to corporate finance, partly as a dynamic response to long-term developments in money markets. The banks established a set of relatively simple rules that could assure internal organizational conformity and minimize risk. The transaction bank strategy consisted of the maintenance of a highly liquid asset portfolio (with a large proportion held in cash or in balances and securities that could be quickly sold on the London markets); careful screening of applicants for loans (to eliminate at the outset high-risk borrowers and/or projects); lending only short-period loans (typically 6–12 months) that were subject to both regular review and immediate recall; high collateral requirements if there was a whiff of any unusual risk (typically, the bank insisted on holding security of equivalent value to the loan so that if default should occur the bank would be able to recover its money); and regular monitoring of the workings of a business client's account.³

A number of important consequences followed from this strategy. First, the banks were rarely involved in providing medium- or long-term capital funds for their business clients. Second, the banks required only the minimum of detailed information on, and minimum involvement in, their client's business (requiring balance sheet statements, proof of ownership of assets, and such like, but no engagement regarding strategy) because if the borrower was able to meet the tight threshold requirements regarding collateral, short-period loans, etc., the danger to the bank's interests was already minimal. Thus the bank could avoid the high cost of more detailed engagement with the client (such as site visits, appraisal of firm strategy, appraisal of new products, and so on). In other words, this was an arm's length approach to corporate finance, adopted by all the leading commercial banks in England and Wales. One important consequence was to minimize losses on bad debt and to instill a degree of systemic stability that was the envy of the world, not just at the turn of the twentieth century but most obviously during the international money market troubles of the 1930s, probably reinforcing leading bankers' adherence to the prevailing strategy.⁴

Seen within a very long-term perspective, an important issue is whether an industry-wide commitment to a "transaction banking" strategy that had been developed in the competitive conditions of the pre-1914 world was still appropriate to the 1940s and beyond—or were the leading commercial bankers' mental models of their "legitimate" market constrained unduly through their collective resolve to hold on to the tenets of transaction banking? This is the issue explored here. In the next section we introduce the concept of industry-wide cognitive inertia as a means of increasing our understanding of bank behavior. We then briefly discuss some of the commercial and political pressures affecting bank lending in the period. In the first substantive section, we detail the clearers' provision for SMEs (small and medium-sized enterprises) and, in particular, focus on an internal analysis and proposed initiative for altering the approach of one of the market leaders, the Midland Bank. This is extremely revealing of contemporary bankers' attitudes and practices toward business loans. In...