Eric DeArmitt, Nucleus Commercial Finance
Lending has been in the spotlight in recent weeks, with regulators and policy makers across Europe deliberating on how to improve the landscape for credit while removing unnecessary risk. But what do these announcements mean for small businesses in need of credit to survive and thrive?
News from the European Central Bank (ECB)
A recent ruling by the ECB has been designed to reduce the “bad debt” within banks, which makes it hard for them to lend. However, in the short-term, the changes could see banks scaling back their lending to businesses, as they learn to adjust the way they work. The ECB’s aim is to stop a new pile of problem debts (currently at €1 trillion) being built up inside eurozone banks, by forcing lenders to be more prudent about the way they handle new customers falling behind on repayments. Starting from 1st January 2018, banks will have at most two years to set aside enough funds to cover 100% of any new non-performing loans, to ensure they can survive in the event that loan recipients default.
This could be bad news for businesses in the short term, who can expect even more risk aversion from banks, regardless of the business’ financial stability. Small businesses will probably be the hardest hit. In the meantime, loan rates from banks will likely rise, especially for unsecured debt and for businesses suffering from a downturn or a weakened balance sheet.
Restrictions on consumer credit can affect businesses
Meanwhile, the Bank of England’s Financial Policy Committee (FPC) has claimed that British high street banks risk losing as much as £30billion from consumer credit defaults in the event of another economic crisis, due to them using the wrong benchmarks to assess risk. This too could have negative effects for businesses.
The key issue according to the FPC is that banks are placing too much weight on the recent performance of consumer lending, which shows low default rates. Theselow default rates are in part due to strong economic conditions including reduced unemployment. FPC’s review of the situation shows that in relying on this recent data, banks are underestimating the losses they might incur should the economy turn.
While this review is centred around consumers, small business owners should keep note of the changes for two key reasons. Firstly, these enterprises are likely to feel the pinch as banks rein in their credit, in an attempt to hold more capital as a buffer against a potential downturn. Secondly, this news proves once again that banking credit risk assessments are far from fool proof.
Brexit and lending
We’re set to see additional challenges arise for mid-sized companies seeking finance post-Brexit. In its latest update on potential risks to financial stability, the Bank of England said: “The risk of disruption to wholesale UK banking services appeared to be slightly higher than previously thought, given that a number of European Economic Area (EEA) firms branching into the UK were not sufficiently focused on addressing this issue.”
With companies from EEA countries providing about 10% of lending to UK businesses, small and mid-sized enterprises may see some lending decline post Brexit.
What can businesses learn from this?
While banks have been seemingly overzealous in their credit approvals for consumers, small businesses have fallen victim to excessively risk-averse tactics from banks in the years since the banking crisis of 2008. Clearly, this broad-brush approach to assessing risk doesn’t work, often resulting in businesses receiving too much, or too little credit and in the case of small businesses, frequently none at all.
Relying on rigid, outdated rules to assess risk, banks are not best placed to take the highly tailored approach to lending that smaller companies require. Without the time taken to properly assess the individual situation, many small business loans are broadly determined as too risky and simply declined by traditional providers.
Alternative lenders have been borne from this rigidity, offering a more flexible, tailored approach to assessing risk, by combining innovative, time-saving solutions, with the expertise and consultancy of a bank.
The alternative approach in practice
Expert Tooling & Automation Ltd, a highly respected supplier and manufacturer for the British automotive industry, came to Nucleus because the company needed to replace its existing Invoice Discounting facility whilst retaining the same pre-payment and funding limit. The funding was required to continue supplying specialist assembly line components to clients including Jaguar Landrover, Aston Martin and Nissan.
This heritage manufacturing business had gone from strength to strength in recent years, increasing turnover by five times in under seven years, yet its finance provider pulled back. Although still retaining a solid balance sheet and order book, after several overseas contracts ran into difficulty, Expert Tooling & Automation Ltd was asked to seek alternatives.
The deal was complex, with a high concentration needed for one of the debtors and it required a specialist understanding of the industry to structure the facility appropriately and support the client’s operations – the type of deal that traditional lenders recoil from, because of the input required.
After spending time getting to know the company, we were able to match the previous provision and deliver the bespoke £8 million Invoice Discounting facility that Expert Tooling & Automation Ltd required. The funds have enabled Expert Tooling& Automation Ltd to continue providing a great service to clients and crucially, to grow.
Growing a business in adverse times
For a business looking for growth finance, news seems to be appearing every day, which sets a bleak picture of the current lending market. But businesses should not be disheartened. With the current turbulence in the traditional lending market, businesses should seek alternative finance lenders that have a true understanding of the sector and can support businesses of all sizes from start-up to small, mid and larger enterprises. These companies need to set themselves up with a lender who is committed to a long-term partnership, rather than a one-off cash injection.