May 16, 2013
Wanted: smart new bank that gives us the credit we're due
A friend of mine, a small business owner, is typical of many thousands of cash-strapped entrepreneurs in Ireland at the moment.
He has a small business and the demand for his product is strong. The market is resilient and in any other country he’d be fine and probably employing a few more people.
He is in the reasonably enviable position of having customers, but as he has no credit, he finds it almost impossible to trade his way out of the current difficulties. Many business people have neither customers nor credit, this man has customers but no credit and because he has no credit he can’t buy his stock and without the stock he has nothing to sell. He is turning away good custom – custom that has been with him for three years – because he doesn’t have anything to sell to them.
Up until last year, the importer of the products (from the UK) normally extended credit to its Irish retailers. The retailers then could stock up, wait for the punters to come in and, once the products were sold, the supplier was paid.
Given the extreme openness of this economy and our reliance on many products made in the UK, this type of arrangement would be entirely normal.
But all this stops in a credit crunch. Normally, the supplier can offer credit terms to his retail clients because his bank is giving him decent terms, so everything flows from the top.
However, let’s go back to the bottom, to the retailer who has a shop on the street of your town. He pays staff and rent and is the end point of the domestic economy.
His story is the story of the credit crunch in middle Ireland. It is the tale behind the Central Bank’s credit figures, which tend to be announced every month on the news. My friend is debt-free. He has always traded tightly and yet now he is on the verge of going under.
A credit crunch spreads like a virus through small businesses, from small supplier to small supplier, as everyone chases outstanding bills. As the chase intensifies, credit terms get shorter and shorter and in the absence of a large provider of credit, such as at least one healthy bank, the system dries up.
It is worth fleshing out what happens when credit begins to dry up.
It begins with the banks not extending liquidity and working capital to decent businesses, because the banks themselves blew their balance sheets by excessive lending. They are deleveraging and are paying back money to their creditors. The banks have to get their loans to deposits ratio down to 100pc, this means taking in more money and lending out less.
Banks rarely stop lending because they want to. After all, this is what a bank does, it makes money from lending to people. In a credit crunch, the banks are compelled to reverse a decade of reckless lending.
The credit crunch spreads like a virus in a creche because everyone – even businesses that manage to keep their credit lines open – can get nobbled by a supplier that is in trouble.
This supplier may look for an extension and, in a short while, the balance sheet of a strong trader can begin to look messy. Where there used to be cash, there are now creditors. Where there used to be money, there are now IOUs.
The bank sees these and gets windy. Working-capital limits are then cut. This will be particularly the case where small businesses are involved because the bank will be cost-cutting and slashing headcount. Maintaining relationships with small businesses is costly and banks in cutback mode will keep the large accounts serviced and just ignore the smaller ones, particularly if they are troublesome.
This brings to mind Mark Twain’s famous quip that: “A banker is a fellow who lends you his umbrella when the sun is shining, but wants it back the minute it begins to rain.”
FOR many small businesses, one of the main reasons why they have seen their balance sheets weaken is that, at the height of the boom, many were advised by pension sharks, bankers and the like to convert their cash on the balance sheet into deposits for leveraged land speculation. The flipside of leverage in a boom is deleveraging in a crash.
As the nation tries to pay down debt and sell the assets on the balance sheet, the price of assets will fall further. And because the price of assets, such as houses and property, is falling much more than interest rates are falling, the negative impact of the debt on the balance sheet is amplified enormously.
Rising property prices in the boom implied that the real cost of borrowing was negative – because if prices were rising at 15pc per year and the interest rate was 5pc, the real interest rate was minus 10pc.
Now think about when the price of property is falling and the rate of interest is stable – the real rate is massively positive, crippling the borrower. This process is far from over.
Up until now, the banks have been hoping that property prices will rise again, this is why we have not seen so much property being sold. However, all this is changing.
In my local town, five properties have come up for sale in the past two weeks. There will be more. This is a sign that we may be going into the final phases of the property cycle. The banks have given up on the market and are going to sell at whatever price they can get.
My friend with the cash-flow problem still faces his dilemma because the banks will not lend for cash-flow purposes when they are in deleveraging mode.
So where is the opportunity? There is an enormous opportunity for a new bank to come into Ireland that can extend working capital to decent businesses. It would seem to be obvious for the State to make a few new banking licences available and then actively go out and solicit business. New capital will dramatically increase the potential of this country.
Credit is a virtuous cycle. You give one guy a few more months and some cash and he gives the next supplier a break, then the retailer can get stock and have enough time to sell and the process of commerce kick-starts again.
It is win-win for everyone. Surely that’s not beyond us?