This is the third in a series of posts centred around the article ‘How should we fund the UK’s growth agenda?’ posted earlier this month. In the article, the head of the Business Finance Task Force asked for ideas on ways to transform lending and fund UK growth.
I extracted key questions (in quotations) from the article and framed my views around them below.
I think the Task Force is asking some interesting questions, and if it is able to address some of the hurdles to business liquidity, will make the coming years very interesting for business in the UK.
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“Are there potential providers of longer-term credit in other sectors of the economy, such as pension funds and institutional investors, and how do we optimise the rules to encourage investment? “
Institutional investors have to manage diversification and while they oversee risk carefully, they focus on investment instruments and corporate analysis at a higher level, and may not presently have the resources necessary to assess and manage SMB loans. In my opinion, banks and asset lenders are presently better geared to manage business lending relationships.
This can be easily rectified by technology and through creating joint venture/partnering arrangements with experienced commercial lenders to manage day to day risk. Perhaps fund managers may be able to convince their investors to create commercial financing funds that focus more on working capital and business lending if they are able to demonstrate that they can attract returns superior to conventional lenders. Either way, some re-allocation of management fees will probably need to take place for this to happen.
A key hurdle for fund managers of institutional funds will be asset allocation: treasuries, fixed income, equities and properties already balance portfolios and the larger general funds tend to have low allocations for ‘risky’ assets such as private equity. Hence, for commercial lending to find meaningful weighting within an investment manager’s portfolio will require sweetener: either a tax break on gains, a higher rate of return or a special/favourable risk classification.
In some countries, I have seen infrastructure projects receive a special status that results in the regulator viewing these assets as less risky than normal corporate debt. This status is can sometimes be based only on implicit support rather than a firm undertaking from the central bank or the government, but its designation makes it easier for asset managers to fund such projects.
We have heard numerous mentions of increased state guarantees for business loans – perhaps this would be better targeted at the institutional sector to widen the number of commercial finance sources.
“We also need to consider how the large financial surpluses held by larger corporates could augment traditional bank lending through different forms of business-to-business financing.”
Today, corporates have two ‘keys’ at their disposal: to pay their suppliers quicker; and/or to arrange supply chain financing. A third ‘key’ is not really in their control, which is that if they borrowed less from a shrinking loan pool, there would be more available to deploy in the SMB segment.
A large proportion of business cash flow is tied up in receivables – mostly larger corporates who take 30-90 days to pay. Some corporates use supplier money as investable assets, maximizing their return at the expense of the SMB. Whether they sit on the cash as long as possible, or ask for an early payment discount, they are effectively acting as treasury investors.
Cash rich corporates could lend to businesses (who are not their suppliers) but again, the issue of having the resources to manage the outstanding loans needs to be dealt with.
The approach I favour is to improve visibility for all connected lenders and businesses, and as a direct result, increase credit available for working capital.
Whether the cash flow is released by early payment, an asset financier, a bank, commercial debt fund, a peer to peer lender or even a cash-rich unrelated corporate does not matter. As long as lenders can see borrower information, borrowers see when they will be paid by their customers, and customers are able to see the benefit of keeping their suppliers informed, cash can flow smoothly.
In addition to the 21st century working capital network that brings all these parties to the table by being vendor neutral and lender neutral (bringing even competitors together via a common platform to yield benefit to the wider population), there are still some older banking industry approaches we can add to the mix.
Recalling the days when we had merchant banks and discount houses, businesses effectively created IOUs that were sold to institutional and private investors, corporates and even other banks.
A bank generally stood behind the IOU, but the business would be doubly worried about the bank coming after them as well as their reputation in the community. A default would effectively cut off any supplier credit they had in place and make day to day trade very difficult.
Perhaps a review of how such standby risk would be classified on the bank’s balance sheet could be looked at from a regulatory perspective. Furthermore, such arrangements could also benefit from any government guarantee schemes. Moreover, institutional investors are likely to be better equipped to fund this businesses in this way rather than direct loans.
“Are there, for example, ways in which finance can be made to work more effectively up and down the supply chain, such as where the larger providers of plant and machinery can finance its acquisition or lease by smaller companies which use it?”
Vendor finance is well established in all aspects of the economy, ranging from furniture on credit for consumers, to vehicle financing for consumers and businesses, to plant and machinery leases. The vendors need a bank willing to create a vendor financing facility. With wholesale funding in its current contracted position, larger and more expensive transactions tend to suck up funding available for smaller vendor transactions.
I think that here the vendors tend to find a way to boost their own sales by securing credit lines for their customers. Where this is possible and cost effective. Given other areas that could be fixed to greater benefit, I am not sure there is much that can be done to boost vendor financing.
“Direct issues of bonds to retail customers and accessing finance through crowd-funding, where individuals get together through networks to provide loans or investments. “
Present regulation and disclosure requirements may make bonds expensive to sell to retail customers. Assuming that regulation of retail customers is loosened, I think a practical solution would be to allow purchase of backed instruments (bankers acceptances, bills of exchange etc.) which would add a level of comfort for the retail client and provide a roadmap towards a smaller bond market. Having the bank or asset lender in the middle would make it easier for the retail customer to access these instruments as they would simply be taken up as fixed term security. I was not keen on banks acting as arrangers in my first post in this series, but in this instance, the banks would be integral to the process, equally liable and not packaging off the risk to someone else.
As I mentioned in my previous blog posts, I am a fan of crowd funding, provided that the individual lenders have enough capacity to absorb a loss, and possess enough of an understanding of business to make an informed decision. I note some P2P lender platforms have their own way of scoring credits and while these may suffice for smaller loan exposures, the issue of adequate credit information still remains an issue.
It may be that collaboration between distribution channels (P2P, working capital platforms, auctions, information providers etc.) may resolve the information and visibility issue (if presented with tangible benefit, businesses would willingly provide their information) and create an interconnected financing infrastructure.
With the challenges facing European banks today, banks have less to lend and are certainly not going to relax their lending criteria. Hence, we have to be innovative with technology, and more open to collaboration between different paths to liquidity.
Whatever we do, it will need to transform the way businesses manage cash flow and commercial financing.