What's the difference between "banks" and "debt collection agencies"?

A rallying cry of the Home-Owner-Ist élite over the past few years has been along the lines of this:

HOW DOES ONE shore up the balance sheets of Britain’s banks while encouraging more lending to cash-starved SMEs? Not since the riddle of the chicken and the egg has a puzzle so confounded the business, financial and political communities in the UK.

Corporate lending is essential for the expansion plans that are so vital to the economic recovery and job creation the government craves...

We know that the best source of cash for business expansion is retained profits and that the bulk of credit creation goes into asset price bubbles, but putting that to one side, where do people expect banks to get the money from? If a borrower is bringing forward consumption or investment, then somebody else (the ultimate lender) must be deferring it. That's where the money comes from.

1. Let's start from the other end and look at debt collection agencies. There are lots of different kinds of these with different names (discount house, debt factoring, invoice discounting) but let's just imagine a plain vanilla version. A productive business might not be very good at the nitty gritty of actual debt collection (sending chasing letters, applying to the County Court, contacting credit rating agencies and sending the heavies round etc) and it might see things as bad for customer relations, but on the other hand, it might want to provide goods or services on credit - gambling that the extra profits generated are in excess of the inevitable cost of bad debts.

2. So instead of selling strictly for cash only (coins and notes) and having a turnover of £1 million and net profits of £100,000, the productive business is happy to sell another £0.5 million on credit, increasing profits to £200,000 (marginal profits being higher than average profits). As long as no more than a fifth of those credit sales turn into bad debts, the business is happy.

3. The business then extricates itself from the messy business of debt collection by selling that £0.5 million to a debt collection agency for (say) £450,000 non-recourse up front and is ahead of the game. The debt collection agency in turn has to collect more than ninety per cent of those debts.

4. Now, perhaps that agency is so well run and has such a good reputation that the business doesn't actually need to receive its £450,000 immediately, it might be happy to leave the bulk of that on account with the agency to be withdrawn in stages as and when it needs it.

5. Taking a bit of a leap here and cheerfully ignoring the regulations on who is allowed to act as a "bank", imagine that Mr A wants to buy Mr B's house for £200,000 but doesn't have £200,000 ready cash (and Mr B does not want to immediately spend all that cash on another house). They could agree that Mr A moves in and pays Mr B the amount in instalments with interest over ten or twenty years.

6. But then Mr B is exposing himself to the risk of Mr A losing his job or being a bad payer, and then he has to go through the rigmarole of repossessing the house which is messy, expensive and unpleasant for all concerned. Or Mr B might decide in a few years' time that actually he wants £50,000 all in one go to buy himself a flash new car, but of course Mr A can't just stump up that amount of money.

7. There's no reason why Mr A and Mr B can't avail themselves of the agency's services. The agency collects the £200,000 in instalments with interest from Mr A over the next ten or twenty years, and because Mr B doesn't want to spend all the money at once, he is happy to leave his £200,000 on account with the agency, taking a share of the interest. And because the agency has entered into dozens or hundreds of such deals, the fact that a couple of the purchasers lose their job or turn out to be bad payers doesn't matter so much to the dozen or hundred vendors, it all averages out.

8. So there is a steady flow of cash income from the purchasers. Also, the cash withdrawn by all the vendors in any period will average out - some will want to make larger withdrawals to buy that flash new car, others will decide that they quite like earning interest and will not withdraw anything.

9. Having got this far, other people with spare cash (i.e. who have earned money but want to defer consumption) might think that placing their money on account with the agency to earn interest is a good deal, which increases the sources of cash inflow to the agency, and these deposits can be used e.g. to repay existing vendors.

10. Of course, if one man is deferring consumption/spending, somebody else must have brought forward consumption/spending, and the agency can now lend money to such people. The agency now no longer needs to wait until an individual transaction has taken place and a financial liability/asset has been created (like the sale on credit by Mr B to Mr A). By taking deposits and lending out the cash simultaneously, the agency is at the heart of the transaction (the acceleration and deferment of consumption/spending).

11. Once the agency's reputation is good enough, it won't need to wait to take deposits first - it can just give a "borrower" a piece of paper saying that the agency will credit the recipient (i.e. the business where the borrower spends his money) with that sum of money in his account, and the agency just has to gamble on those pieces of paper ending up in the hands of people who will not want to withdraw the cash immediately.

Q: How does this agency's activities now differ in any way from the activities of "banks"?

A: They don't. The two are exactly the same.

So when the cheerleaders say that "we want to get banks lending to business again", they are just saying that instead of everybody and every business consuming (or reinvesting) what they produce as they go along (a perfectly imaginable and stable state of affairs), they want one group of people to get into as much debt as possible (by bringing consumption/spending forward) and for another group of people to defer as much consumption/investment as possible (an unstable state of affairs).

Just sayin', is all.