Our financial institutions split their organisations into various segments. Invariably, they target most of us at the lowest (retail) segment and institutions at the highest. The middle is defined as everything in between. Most banks define this middle as any organistion that requires funding less than a specific amount (around $50M depending on the organisation).
In the middle of difficulty lies opportunity – Albert Einstein.
This middle is further segmented and variously labeled as SME, business banking, corporate banking, or other similar titles bestowed to the segment. This is the segment that, we feel, has been serviced poorly in the past 7-8 years.
Why? Let me explain.
If a potential bank client walks in to a bank and says they want to borrow $20M. They are referred to a business banker. The business banker then looks at what the borrowing is to be used for and if it fits within that bank’s policies. The next stage is to look at the cash flow of the potential borrower to ensure that servicing the debt will not be a problem. Finally, and this is where this segment is poorly served, the banker will look at what is being offered as security.
Generally, if the security is anything other than real property or cash (and the client is unrated by a rating agency – and most will be), then the banker politely declines the business. Why? Because global bank regulators introduced regulatory controls around who banks can lend to “unsecured”.
In this case, the bank would need to place additional capital against the loan making the whole exercise uneconomic (for the bank). The result being that a successful business that has good cash flow is excluded from accessing working capital.
These businesses are then served by private lenders that charge handsomely (between 8-15%) for their services. My belief is that the global economy is being held back by these regulatory impediments – because they are applied globally.
Interestingly, we are working with a European bank to establish private funding for one of our clients. The sad thing is that European banks currently have negative interest rates to encourage them to lend their money out. But if they lend to unsecured and unrated borrowers, they have to find additional capital. So they’re forced into structuring debt deals with private funds.
This Catch 22 will continue as long as regulators believe that these capital controls (part of a regulatory regime called Basel III) are de-risking banks and that they’ve fixed the financial system. Further, governments will not interfere for fear of bailing out their banks if things go wrong.
But the cost of inaction is incalculable. One solution is to broaden the definition of security to include assets other than property or cash. The asset(s) to be considered would depend on the industry of the potential borrower and could be addressed by slight amendments to banks’ industry policies.
For example, in some cases (say for small financial service firms) receivables can be offered as security. This is happening with private funders but banks are steadfastly refusing to allow the inclusion of receivables as security in their business banking segments (however, they do allow this at the institutional level).
Madness.
It would be easy for politicians and the media to blame the banks for this massive service gap. While I’m not a defender of banks, I know how they operate, so I won’t be jumping on that bandwagon. If you (government through the regulator) give a bank little or no incentive to lend to a large chunk of your economy, you then can’t complain when they refrain from lending.
Banks’ responses to regulation is binary. They either will do business if the regulatory rules allow them or won’t if the regulatory rules don’t.
So, to those strong middle businesses that have tried to access bank funding and failed, we can help you…but at a cost.