Tuesday 24 October 2017

Bypassing banks a way to avoid credit roadblock

Personal and business customers of banks will need to be up to speed with changing financial services in a credit-challenged world, writes Harry Slowey

What will financial services look like over the next 10 years for you as a personal financial consumer or an SME businessperson? It will be quite different from the last 20 years, and these changes are becoming evident now.

Is the present banking landscape the legacy of a credit-fuelled past, or is this what the future looks like? Prob-ably both.

There will be fewer banks in Ireland. The banks that do exist will not be 'chasing your borrowing business'. In fact, new lending will be very tame and the cost of lending will be more (much more) expensive.

For the next 10 years banks will seek to 'shrink' or deleverage their balance sheets. Banks will achieve this by selling their loan books and not growing their lending.

Ireland will go from a very competitive banking industry to one that will not have enough competition.

So what does this mean to you? If you are a borrower or seeking lending from a bank, the cost of the lending will be more expensive. The banks will look for much more information before they lend the money. Once they lend the money, they will also be seeking more control of it by getting updated regularly by you on your personal or business affairs.

The terms 'non-recourse' and 'equity releases' will be consigned to history, and banks will be looking for a much higher level of cash equity put into deals.

Banks will be pursuing business areas that do not grow their balance sheet. This includes trade finance, clearing and transmission businesses, pensions. These products are much more attractive to banks now as they do not have to grow their balance sheet and do not require much capital.

The pendulum of leverage has definitely swung from borrowers to depositors.

So what should you do next? For business people, you need to reduce your overall reliance on bank credit. If you don't, the banks will possibly have more control of your business than you. Secondly, a greater part of your profits will be paid to banks for more expensive credit.

Businesses did get lazy over the last 15 years, and allowed bank funding to replace the rigours of working capital management. Some businesses are more reliant on banks than others. Thus it will take some time to reduce their credit and bank dependency.

Funding is required principally for trading or investment purposes.

For trading purposes, the key issues for customers are: how can you reduce this bank/credit dependency? Are you managing your stocks and debtors as well as you need to? Are you chasing your own debtors to pay up? Are you giving cash discounts for early settlements? Is your management information as good as it needs to be, and are you using it properly? Are your sales people too focused on selling and not on collecting cash? Have you checked your credit rating lately, and can you improve it?

There is a need to hold a mirror up to your business. You need to squeeze more cash out of stocks and debtors and to maximise your credit rating to ensure that your creditors are giving you longer trade periods.

Equally, are you allowing your business to become the funder of your customers in the absence of a traditional banking market?

More efficient management of some of the above will reduce your need for bank credit, lower costs, and give you more control of your business.

On investing, can you by-pass a bank or reduce its involvement? Have you thoroughly analysed the investment decision to ensure the returns compensate you for higher borrowing costs? Are you deferring capital payments with the seller of the business/capital equipment to reduce the bank funding needed?

Increasingly, we will see the bypassing of banks where goods manufacturers or asset sellers can 'supply' the funding to ensure their goods are sold. This is 'vendor finance' when the vendor of the goods becomes its funder.

Depositors: this is a great time to be a depositor. Banks are 'paying up' for deposits given the regulatory need for this type of funding. Unfortunately this is all paid by new and existing borrowers. Depositors need to maximise deposit rates whilst being aware of the risks facing the banking sector and currency markets. Cash has gone from an inactive asset to an active asset.

Credit rating: have you taken maximum advantage? In the absence of bank credit, trade credit will be increasingly important.

Every company in Ireland is on at least 10 credit rating agencies and eight credit insurer databases, but few know this.

Right now, in these tough times, credit capacity is reduced, suppliers are risk averse looking for cash payments, risk assessment models have evolved and business information credit reports are in use far more regularly.

The credit risk markets have changed forever. Companies must realise that the risk rating market is different forever with any benefit of doubt now gone.

Irish credit risk is now assessed by international standard models and not always by people entirely familiar with the Irish market. Your credit value is being set without your input. Where do you find out you have a problem? Invariably it is after the event, with a key customer having indicated a problem to you.

Often you will find that you have to re-prove your credit value several times to different parties.

Generally relationships with credit insurers and rating agencies have not been a priority for business as credit had been so freely available ... not anymore.

New providers of finance: we are starting to witness the arrival of new fund providers in niche areas like invoice financing, asset financing and trade finance.

They will not replace the historical banking infrastructure, but will provide some alternatives in certain limited situations. They will be more expensive as the cost of funding is more expensive.

Given the increasingly high cost of regulatory compliance for banks, there will be opportunities for lesser regulated lending entities in the future.

We will see the decoupling of banking services and personal financial services.

In conclusion, consumers and business people will need to become more informed about financial services. They will need to adjust to a credit- challenged world that has direct implications on how they save, borrow, and interact with institutions they grew up with. There will be a big step-up in regulation throughout financial services. They will need to take more responsibility for provision of retirement benefits. They need to become more risk-aware and act accordingly.

Harry Slowey is a co-founder of Finance One. He was a director of Bank of Scotland (Ireland) for 13 years, until 2005

Sunday Indo Business

Also in Business