What’s Killing Productivity? Some Think It’s the Banks

LONDON—The birthplace of the industrial revolution is in dire need of innovation. Standing in the way: Britain’s mortgage-laden banks.

The U.K.—inventor of the factory system, steam engine and passenger rail—is at the forefront of a 21st-century global productivity slowdown. Growth in U.K. productivity, or output per hour worked, has halved since the financial crisis, leading some policy makers to call this era Britain’s lost decade. Among the world’s seven largest developed economies, only Italy has fared worse.

The causes are hotly debated, and include an ageing population, tighter regulation and the U.K.’s departure from the European Union. But a factor that has gained special attention: the way U.K. banks have tilted lending to the booming housing market.

Bank lending for projects that boost economic output, such as machinery and software, has stagnated. Research and regulators say the two trends are linked: As real-estate prices soared, banks shifted more capital toward housing, viewed as less risky because the loans were backed by tangible assets with rising values.

“The banking system is increasingly becoming a brake on the economy,” said Jonathan Haskel, a member of the Bank of England’s Monetary Policy Committee.

The U.K. is an extreme example of what’s happened in big economies around the world for the better part of this century. Central banks cut interest rates in the 2010s through early 2022 to make it cheaper for businesses to borrow and invest. But while debt rose sharply, most of it went toward real estate.

The world’s total assets—including those held by households, businesses and banks—more than tripled from 2000 to 2020, according to a report from the McKinsey Global Institute, a research group. Two-thirds are stored in real estate; only a fifth are in productivity-boosting assets such as factories, equipment and infrastructure, McKinsey said. “The historic link between the growth of net worth and the growth of GDP no longer holds,” the report said.

Among the world’s 10 biggest economies, the U.K. is tied with France for having the lowest share of net worth in assets that boost economic growth. Meanwhile, the U.K.’s home values and mortgage debt have exploded.

U.K. banks added £400 billion, equivalent to about $500 billion, to home lending in the decade through this February, Bank of England data show. Debt extended to businesses grew by only one-tenth of that amount.

The U.K.’s big banks “pulled back in the financial crisis and never really came back” in terms of business lending, said Richard Davies, a former regional head for Barclays’s U.K. business banking operations who now leads Allica Bank, a London startup that lends to small and midsize businesses. “The big banks are obsessed with residential mortgages.”

The obsession with mortgages leaves some businesses feeling sidelined.

Geometric Manufacturing, based in Tewkesbury, England, makes defence and cybersecurity products. Several years ago the firm asked a U.K. bank for a loan to design and manufacture a robotic arm to load its machines, an investment that would allow the factory to produce more with fewer workers, Managing Director Paul Wenham said.

Despite the option for a government guarantee through a U.K. program to help small businesses, the bank declined to participate, Wenham said. The company eventually received a small loan from a London-based startup lender. The loan came with a high interest rate and was smaller than what the company had sought.

His inability to get a bigger loan delayed the project by years, Wenham said. “We could have been reaping the rewards and benefits so much sooner,” Wenham said.

Dozens of startup lenders have stepped in to fill the void created by the retrenchment of big banks. They provided about half of all new loans to small and midsize businesses last year, government figures show. But they charge high interest rates on business loans, said Mike Conroy, director of commercial finance at UK Finance, the banking industry’s main trade group.

Conroy said the biggest factor behind weak business investment is a lack of demand, not supply. Many entrepreneurs are reluctant to take on debt, or simply don’t aspire to grow, he said. “The U.K. has many small businesses making a great contribution to the U.K. economy and local communities, even though they don’t aspire to be the next Microsoft or Google,” Conroy said.

Research in the U.S. and Australia shows that banks respond to rising home values by shifting capital away from businesses. U.S. banks located in areas with robust housing markets in the early 2000s bubble boosted mortgage lending while cutting business lending, according to a 2018 research paper in the Review of Financial Studies.

In the U.K., rules put in place after the financial crisis force banks to hold higher levels of capital for business loans, which are deemed riskier, than for mortgages.

Matt Hammerstein, CEO of Barclays’s U.K. operations, said banks have increasingly required all borrowers—whether homeowners or businesses—to put up physical assets that the lenders could sell if the borrowers fail to repay. Many business owners refuse to put up their assets, such as homes, as collateral and thus don’t win approval for loans, he said.

“What banks have done over time in order to be able to underpin their risk appetite is to expect entrepreneurs to put more of their own equity at risk,” Hammerstein said. “If you’re lending to a small business, particularly one that has intangible assets, you’re going to want some collateral.”

Default rates among established small and midsize businesses is low—about one in 50 will default in a given year, said Davies of Allica Bank. But determining each company’s risk—and thus what interest rate to charge and how much capital to hold—is less accurate and more time-consuming for big banks, which have instead shifted resources to mortgages.

In 2018, Jurga Zilinskiene wanted financing to develop software to expand her London-based language-translation business, Guildhawk. The 40-employee company translates documents for companies around the globe.

She asked a big U.K. bank for a seven-figure loan; they lent her a fraction of that, citing her lack of tangible assets that could back the loan if she defaulted. Many of her assets are intangible, such as intellectual property.

She worries that banks are too focused on making a quick profit rather than supporting the long-term health of the economy. “How can I compete with global enterprises in the United States, China?” she asks.

Note: Usual Northern Sea Route shown for illustrative purposes Source: Sea Legend Daniel Kiss/WSJ

Shipping cargo through an Arctic shortcut never made economic sense—until now.

Climate change and war in the Middle East are flipping the math that previously kept ships plying longer routes from Asia to Europe. A Chinese company on Saturday is starting the first regular cargo service to Europe through Arctic waters, seeking to reap the benefits of quicker travel time and less fuel use.

The shipper Sea Legend will dispatch the Dubai Tower from Ningbo, China, to Felixstowe in the U.K. on what it calls the Arctic Express, following a route along Russia’s north coast. The voyage by the vessel, which is capable of carrying 1,740 20-foot containers, is the biggest commercial step in the Arctic since a Maersk containership first completed the route in 2018.

Global warming is a big factor behind the new route, but it is not the only one. Nearly half the Arctic region’s summer ice—an area four times the size of Texas—has melted over five decades, clearing a fairly reliable path in the summer months. Meanwhile, high oil prices and attacks by Houthi rebels in the Red Sea have made the traditional routes costlier and more dangerous.

Members of China's 16th Arctic Ocean scientific expedition team take selfies on the ice surface. — Members of a Chinese scientific expedition team on surface ice in the Arctic Ocean this week. Wen Jinghua/Xinhua/ZUMA Press

Beyond that, Beijing has ambitions to play a role in the Arctic’s future, lending a geopolitical dimension to the Chinese company’s shipping route.

Last year Sea Legend completed a trial run from Asia to Europe in a record 20 days. That is roughly half the time of a voyage via Africa’s Cape of Good Hope that many carriers now take because of the Red Sea uncertainty.

Fuel accounts for 70% or more of the costs while at sea, said Alan Murphy, a former Maersk analyst who runs research firm Sea-Intelligence.

Saving fuel by shortening the journey doesn’t automatically make a route profitable. Insurance premiums for the Arctic are 40% higher than the Cape of Good Hope route, said Jonathan Steenberg, an economist at credit insurer Coface. Sea Legend’s Arctic vessels are relatively small. And even after warming, an icebreaker is still sometimes needed to help the cargo ship.

But if the ship can go without an icebreaker, Coface said the Arctic route is now cheaper than a Cape of Good Hope voyage in some circumstances. It estimated that at current oil prices of around $90, the cost of shipping liquid bulk such as liquefied natural gas could drop roughly 33% compared with the Cape of Good Hope route, while dry bulk goods such as cereals would cost about 8% less.

The container ship Istanbul Bridge being unloaded by large blue and red cranes at the port of Gdansk. — A containership operated by Sea Legend in the port of Gdansk, Poland. jackowski/epa/Shutterstock

The route is only passable in the summer and fall. Sea Legend plans eight voyages between August and late October, before conditions get too icy.

“It’s not the Suez Canal but it’s a significant number for the Arctic. It shows there is potential,” said Malte Humpert, founder of the U.S.-based Arctic Institute and author of a book on Chinese shipping in the Arctic.

Even in summer, ships have to navigate around dangerous ice floes and deal with rapidly changing weather. By the end of the shipping season in October, the sky is dark most of the time.

A Russian tanker suffered serious damage to its hull while sailing along the Arctic route despite being assisted by an icebreaker, its insurer, AlfaStrakhovanie, said Thursday, adding that it paid out roughly $650,000.

Coface estimates 3.5% of trade among East Asia, Europe and North America will be able to use Arctic routes within the next five years, representing $64 billion in goods.

Last summer, a record 23 cargo ships transited the Northern Sea Route, which hugs Russia’s north coast. That is tiny compared with the Suez Canal, where more than 30 ships transited daily.

Western companies that want to follow in Sea Legend’s path have to navigate treacherous politics. Russia claims sovereignty over the entire Northern Sea Route and permits for ship traffic are issued by its state-controlled nuclear operator, Rosatom.

Aerial view of a port with many cargo ships, red cranes, and rows of stacked shipping containers. — The Dubai Tower’s route will begin in the Chinese port of Ningbo. Huang Zongzhi/ZUMA Press

“Western companies are in a tricky position,” said Humpert of the Arctic Institute. “At what point do they jump back in the water? When does it become economically necessary, and how do you weigh that against environmental risks and the political dimension?”

An alternative Arctic route, the Northwest Passage that connects the Atlantic and Pacific oceans via the Canadian Arctic, is less passable because it is dominated by narrow waterways where ice gets bunched up. The highest number of cargo ships completing the passage in a year was 13, in 2023.

China has declared itself a near-Arctic state despite not having access to Arctic waters. It depends on Russia’s goodwill to use the Northern Sea Route.

“Beijing is concerned that if they don’t establish a significant strategic presence in the Arctic now, it’s going to be more difficult in the future,” said Marc Lanteigne, expert in polar geopolitics at the Arctic University of Norway in Tromsø. However, he said, “China needs to be careful not to give the impression that they are trying to challenge the strategic order in the Arctic.”

Sea Legend didn’t respond to requests for comment.

Any polar venture contributes to China’s quest to master Arctic travel. The country also has three icebreakers and a support vessel currently on a monthslong scientific expedition north of Greenland. Scientific and commercial voyages can yield data about natural resources awaiting below melting ice caps and information for positioning nuclear-armed submarines.

What’s Killing Productivity? Some Think It’s the Banks

Bank lending in the U.K. is going to property rather than innovative businesses

China is launching the first regular Arctic cargo route to Europe, offering faster journeys and lower fuel costs as melting ice and Red Sea risks reshape global shipping.