The Government’s move to extend loan guarantees to small firms is a good move and has the potential to unlock a credit bottle-neck, which could help many small firms that are stranded in no-man’s land, living off cash flow and missing opportunities.

Anyone who runs a small business knows that you need capital to grow. It is possible to grow out of cash flow and many thousands of companies have, but when there is a credit crunch going on here and not in some of our competitor countries, Irish firms are at a huge disadvantage.

Business people also know that when there is no investment in a firm, the firm can die on its feet. If a lack of credit means a firm fails to invest, it might look ok on the outside but it is gradually hollowing out its productive marrow and very soon it will be bypassed by better-capitalised competitors.

At the moment, many companies can’t get access to capital because they don’t have collateral. They don’t have enough capital. In comparison with companies in other countries, Irish companies have never really amassed capital or savings.

This is because, rightly or wrongly, we have a debt-financed model of capitalism. In contrast, overseas you will find family companies that have squirreled away cash for years and now have significant capital. We are still some distance from that and most entrepreneurs have no capital to speak of and no access to real capital.

On top of this, the venture industry in Ireland is not very well developed. There simply isn’t enough free capital around to be deployed in the companies that need it. So a typical case would be a fast-growing company that is looking for Enterprise Ireland (EI) help. Enterprise Ireland might have a scheme, which matches capital for equity. So EI will say to the company, ‘We will help you move to the next phase in your development with an equity injection of €1m if you can match this funding with €1m of your own’. The company then has to go to find that extra €1m and it is very difficult. Therefore, loan financing, rather than equity financing, is very helpful in a country with a small private-equity capital base.

Now, of course, turn back the clocks and we had all the capital we wanted and we blew it on all sorts of housing-related El Dorados. But it happened and one of the many disastrous consequences of it is the fact that the banks are bust.

On one side of their balance sheets they have assets — such as land and property — which are falling in value, and on the other side they have loans, which are increasingly going bad. They are terrified to issue new loans.

On top of that, they have to pay back all the money they borrowed to lend to developers to build shopping centres that no one wanted and now are nothing more than holes in the ground. This is called deleveraging.

Rather than actively re-cycle and inject credit into the economy, they are actively and purposely taking credit out of the economy every single day.

When you reduce this story down to the ground level, what you see is that good companies can’t get credit because the banks are overly cautious and the company itself has insufficient capital. With insufficient capital it has insufficient collateral. Collateral is what reduces the lender’s risk. The more collateral, the more comfortable the banks become because they have a buffer.

If administered properly, this loan guarantee might kick off a virtuous cycle whereby companies that couldn’t get any capital can get capital. This will allow them to develop a relationship with a bank and, if things go well, the company can stand on its own and the State can withdraw its support.

The State is likely to appoint an outfit to operate the scheme. This should act as a filter mechanism where experienced lenders — who should not have form in terms of lending to bad companies in the boom — work with the banks to assess each company.

The final decision on which company gets the money should remain with the State’s operator and their job should be to protect the taxpayers’ interests and assess the recipient companies.

There will be loans of €150m made available, with the State backstopping 75pc of these and the banks taking the rest of the risk.

You might think that this is a big chunk of risk for the State to be providing but it depends on the leverage the banks are willing to give. So, for example, the State might have done a deal with the banks to offer three times’ leverage.

So the State puts €35m into the kitty. The banks then put up €115m, which gets the fund up to €150m.

If you assume a loss of 10pc on total loans lent over five years, it means potential loan losses of €15m or €3m a year; 75pc of that is a State write-off of €2.25m per annum. This is the basic model.

Obviously, if leverage is lower or bad loans are bigger, then the exposure for the State is greater. The devil will be in the detail and the skill of the operator.

However, if we start from the premise that there is a credit crunch in Ireland because the overall macro and banking position is horrendous, the implication is that good companies can’t get loans, which means that the likelihood of loans going sour must be less than if there was no credit crunch at all.

The converse applied in the boom, when bad companies got too many loans, pushing up the default rate way above what would be described as normal.

In a situation of a “liquidity trap”, where banks are not lending because of deleveraging and companies can’t borrow because of a lack of collateral, this move is a necessary step.

It’s not a panacea, but it’s a start.

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