So the finger pointing continues. Policy makers are still unhappy with bank lending to SMBs. Lobby groups are not dancing in the aisles about this either and everyone has some ideas on how to tap additional sources. Lending to businesses, SMBs in particular has been decreasing, despite the need for it to grow instead.
I’ve referred in a number of previous blog posts to bank targets and the difficulties banks have faced in lending to businesses. Now, corporates don’t seem to be banging on the pots about their lack of access to credit – I was asked last week by someone in the payments industry what the difference in the value proposition was between a corporate loan and a business loan. His question was, what’s the difference?
The first clue might be in the fact that banks have different corporate banking and business banking units. In many financial institutions, business banking is bundled with retail banking whereas corporate banking forms part of corporate and investment banking.
But where the people are housed is not necessarily what defines the difference (although it could do, of course). Corporates have a large finance and treasury team, whose job it is to maintain relationships with a number of banks.
Being multi-banked, the corporate is called on by its bankers, with offers of funding. Since corporates tend to have more publicly available information (especially publicly listed ones), its bankers are generally able to obtain a fair amount of information relatively easily. Add information from rating agencies, credit monitoring agencies, industry analysts and other third parties and the picture becomes clearer.
The corporate is also called on by multi-disciplinary teams of corporate and investment bankers, who produce a menu of alternatives ranging from ‘vanilla’ term loan facilities, leases, asset backed loans, structured and project financings to more ‘exotic’ instruments and debt programmes. Banks also tend to sell cash management and other treasury products to corporates, as well as foreign currency programmes, payments facilities and other managed services.
Pricing of financial products to corporates tends to be fairly competitive (strong brand names could often borrow at prime lending rates minus a few basis points prior to the meltdown) and the more services a corporate consumes, the stronger tends to be its negotiating position. The environment is not as easy today, so even top corporates do have to work harder to get good pricing, but they certainly have an easier time than businesses.
Corporate treasurers have one main job: optimise cash flow. They therefore look to earn the highest returns on cash balances, pay the lowest transaction fees, pay their suppliers as late as they can, and collect from their customers as quickly as they can. Again, bargaining power is related to size and the more buyer power it has, the more the corporate can force its suppliers to wait longer to get paid. The craftier treasurers take a discount from their supplier (small business) for paying them early (i.e. on time!) and are earning returns on their cash balances (or even borrowing from the bank at a lower cost) at the expense of their suppliers.
The business, on the other hand, having agreed to the longer payment dates to get the sale and keep the business, spends a fair amount of time chasing up its invoices to ensure that it will be paid, albeit later than needed. Whether the owner does the chasing, part time collections people, or a full time controller depends on the size of business. Size also determines whether a spread sheet, accounting package or light ERP system is used to forecast and manage cash flow and collections.
The big squeeze. Business generally have to hunt for financing and knock on lender doors. Some fortunate businesses have developed relationships with a few invoice financiers and banks, and are in good shape as they have been educated on their options and tend to be able to choose between lenders based on price, service etc.
A large number of businesses tend to have one banking relationship and when their bank is unable to give them the credit they need, find they need to scramble around for alternatives. Accountants, advisers, brokers all help them make connections, but this all takes time. Often, time the business does not have, nor can afford.
When the business is connected with lenders, the time and effort needed to give each lender what they need drains time, and requires specific effort over and above the day to day challenges faced by the business.
The effort does not always yield a favourable outcome: by the time the lender has assessed the business sufficiently to decide whether to proceed, valuable time has passed on both sides.
For the lender, originating business lending is also labour intensive. Since there is a lack of publicly available information the lender has to rely on the business and its customers for much of its information.
As a result, the credit appraisal process can take longer, as the business due to its relative size, is viewed as more risky. For a lender that has 10 million to lend, it would be more cost effective to make a few loans to larger entities at a lower margin than assess a larger number of smaller loans (even at a higher margin) to ‘riskier’ entities.
Unless it has the right systems and infrastructure in place, banks find that business lending can be more expensive to deliver than corporate lending. And in the eyes of many corporate credit teams, more risky and more effort intensive.
However, if done right, the margins on business lending can be quite attractive. The opportunity for lenders is to find new ways of obtaining the information they really need, while improving their own value proposition to the business.
After all, businesses need to borrow and lenders need to lend. Financing working capital with equity is not something most businesses have the luxury of doing. And businesses need to be smart about the way they manage their financing and working capital, showing the lender the value in spending a bit more time with them. The BIS Task Force report is due out soon. I look forward to reading some of their recommendations.