The City suffers from a lack of will for reform

Eighty years on, and in spite of the banking crisis sparking off renewed calls for the UK to have an economy which is less dependent on finance, we still have not got the answer. Companies looking for between £2 million and £10 million still drop through a funding gap.

Now one hears that the Government's latest attempt to tackle the problem — a plan to create a National Investment Corporation with a network of venture capital centres across the country — has been quietly ditched.

The idea that the banks should be bounced into providing a pool of funds is still in place, but now what is raised will be channelled through existing City lenders. What is now being called the Growth Capital Fund will be, in essence, a fund of funds that will use existing asset managers to make the investment decisions.

This is absolutely what is not needed. It is not shortage of funds which stops the City from investing in small British business, it is a lack of desire to take the risks and incur the costs which go with backing small new businesses, coupled with, from the fund managers' perspective, a lack of sufficiently attractive opportunity.

But this is where the local knowledge is important because it is tough for small business to get noticed or to afford the costs of marketing themselves to London-based fund managers.

The Macmillan recommendations in the Thirties led to the creation (after the war), of the Industrial and Commercial Finance Corporation, which was jointly owned by the clearing banks. However, it was run independently and its key feature was a network of regional offices through which it sourced its small business deals and became the primary source of venture capital in the UK.

Unfortunately it lost its way and its culture was destroyed when, having been renamed 3i, the decision was made first to go public and then to chase the seemingly better returns available in private-equity and management buyouts.

The change of strategy ended in tears — inevitably — but not before the regional offices had been closed and 60 years of experience and corporate memory destroyed.

It is one of the paradoxes of this country that it has the most sophisticated financial markets in the world but remains one of the hardest places for entrepreneurs to get backing. But in many ways one gets in the way of the other. Those managing money are all too aware of homes for their funds which are easier to get access to and require much less work and risk than backing new business.

It is much easier for them to funnel money into the stock market in Thailand than a new business on Tyneside. That is why the regional centres were so important — they provided those who were dishing out finance with local knowledge and the local entrepreneurs with access to funds.

That is also why creating a National Investment Corporation and then simply giving the money to existing managers the City is utterly pointless.

It is not shortage of funds that is the issue. It is the City's lack of will.

A good time for fund managers

The classic response to hard times is for people to save more — and as far as the UK fund management industry is concerned, that's how it has turned out.

According to the Investment Management Association, fund sales last year were the highest on record and up 45% on the year before. Some £25.8 billion of net new money flowed into the industry, taking the total up to a record £480.8 billion.

Something is clearly going on, but it is hard to know just what. For example, the insurance industry is a major conduit of money for the fund managers, yet almost every life office — with the possible exception of the Prudential — seems poised to announce lower UK sales in their coming results season. So independent financial advisers and wealth managers have clearly taken up some of the slack.

Another possible explanation for the popularity of managed funds is that cash deposit rates in banks and building societies are so low.

The collapse of Lehman 15 months ago ushered in an era of rock-bottom interest rates. Shortly after that, the flows of money started to pick up, initially with the bulk of the money going into high-yielding corporate bond funds and then switching as the year progressed into equity and property funds, and running thereafter at roughly £2 billion a month.

The year has also witnessed the decline in conventional with-profits savings policies continue to be replaced with more transparent and equity-focused unit-linked contracts but the amount of new — as opposed to switched — money involved there is questionable.

Not so with Isas. Indeed perhaps the most significant change of trend in the statistics is that for the first time since 2001 there has been a net increase in sales of this product.

After five years during which this category saw higher levels of withdrawal than investment — including a loss in 2008 of £1.6 billion — the situation was turned around and last year saw net sales of £2.8 billion.

Isas appeal primarily to middle-income groups, so it is not just the well-off who are trying to save more.