Where Are Businesses Turning for Credit in a Strapped Economy?

by Micheal O Callarain on / 1 Comment

Category: Economy, Finance, Sales & Marketing, Strategic Change

 In the current economic market I have more than once mentioned that the real road toward financial stability for Ireland is for SME (Small to Medium Enterprises) to hire. As a general rule there should be around 1 employee per 1 million dollars U.S. in revenue (this is of course an estimate and not a hard/ fast rule). SMEs make up a majority of the business machine in Ireland, and as a result they have to expand and have to hire. Where should they get the confidence in the current environment, where do they turn to in a crunch for capital or the ever popular overdraft to float them through capital fluctuation? A recent study has revealed that in a survey by the CBI and ACCA (Association of Chartered Certified Accountants) 380 UK firms showed that they are increasingly turning away from traditional forms of bank financing and are looking to other sources for their needs.

So where are businesses turning instead of the banking industry, the most common answer is supplier financing from the supply base. The businesses are negotiating alternative terms with their creditors for trade credit in exchange for their goods and services. The only issue with however is that the creditor has now slowed down their accounts receivable cycle and impacted their cash flow. This brings me back to the idea that the strongest businesses with the strongest cash position will come out incrementally stronger following the economic meltdown in Ireland.

To complicate this negotiating terms and negatively impacting your creditor’s accounts receivable cycle carries with it a higher cost of capital. This increased cost of capital must then be passed on to someone to compensate and protect the gross margin of the companies. This cycle is how inflation begins to spiral out of control and prices rise at rates higher than the ideal rate. In short the alternative finance arrangements caused by the reluctance of the SMEs to approach banks leads only to higher prices for the consumer, who coincidentally is the employee of the firm that reached up and raised prices to protect it/s margin . It seems counter intuitive and according the study companies that have operations in Great Britain are faring better with higher success rates on overdraft acceptance when compared to those exclusively doing business in Northern Ireland.

In order to correct the imbalance and avoid another input for an inflationary period the banks need to court these SMEs and return terms that support hiring and job creation in return for solid financing. The financial issue is only the manifestation of the underlying problems with the business market; the real root is a lack of confidence and stability in the business environment. The lack of SMEs seeking financing is proof that the issue is deeper that just the access to capital, but rather access to their government.

The Incredible Shrinking Banking Industry

by Harley Murphy on / 14 Comments

Category: Economy, Finance, Strategic Change

SPECIAL GUEST BLOG By Harley Murphy, Strategic Change Mentor, Mentors.ie

The headline above was the title of a paper in October 2007 by Carl Tannenbaum, of the Chicago Federal Reserve Board, in Business Economics. It was sub-titled “ fewer players in a riskier, more complex game.” In referring to Ireland’s banking industry the main title could remain unchanged but the sub-title should become ‘ fewer players in a less profitable, more traditional game.’

The inflating of the Irish Banking Industry

The charts below, based on Central Bank figures, featured in Morgan Kelly’s paper – “The Irish Credit Bubble” capture in graphic form the bubble inflating. The chart on the left shows bank lending to non-financials in 1997(red) and in 2008 (blue) for Ireland, UK and other Eurozone countries. The right chart shows the growth in mortgages and loan to developers.


How to deal with the rupture ?

McKinsey, in their July 2004 Quarterly, write about their considerable experience in consulting to ailing banks, identified three broad areas critical to banks’ survival after a financial crisis:

1. Managing liquidity
The highest priority for Irish banks at this time must be the restoration of depositor confidence. This will allow them to reduce over time their dependence on ECB funding (euro 97.3 billion: Nov10) and focus on the all important traditional banking ratio of deposits to lending. This ratio will and must be their ‘health’ barometer over the next decade.

2. Reducing the number of high-risk loans; and
NAMA has certainly done the banks no favours in its severe discounting of purchased high-risk loans.

3. Adding fresh capital
With the exception of Bank of Ireland this is being provided by taxpayers. In all cases the required 12% capital ratio will have a severe drag on bank profitability.

What happens next ?

The following are some of the key areas the Irish banks need to focus on over 2011:

  • Staffing – Shrinking assets and profits must also result in shrinking personnel numbers. In order to understand the possible scale of these cuts we can look at earlier severe banking crisis in other countries and McKinsey here refer to the 1998 South Korean economic crisis, where more than 30 percent of the country’s banking employees lost their jobs. This will be tempered somewhat in the short term by the NAMA loan transfers, however, in the medium term we are looking at significantly lower numbers of staff in the Irish banks. Based on my own experience, the way the banks handle these staff reductions will have a crucial bearing on the progress of the banks in once more becoming successful institutions.
  • Corporate Governance – the Central Bank recently introduced a ‘Corporate Governance Code for Credit Institutions and Insurance Undertakings’. This obliges the banks and insurance companies to take governance much more seriously and gives the Financial Regulator strong powers to ensure Boards are knowledgeable and include truly independent non-executive directors. The banks and insurance companies have until June 2011 to put their ‘governance’ house in order and consign to history the cronyism that prevailed for so long in their boardrooms.
  • New Management Teams – a lot has been done here but more change is needed at senior levels in the banks to ensure those who created the conditions for ‘bust’ have no say in the necessary transformation.
  • Cultural Change – related to all three of the above bullet points is the complex issue of changing culture within the banking industry and I will deal with this specifically in the next blog on banking.
  • Restructured Business Models – ‘back to the future’ is probably the best way to describe the business model the banks now need to embrace. A model which has at its core organic growth driven by strong customer loyalty must be the way forward. The chart below highlights the choices and combinations bank management must consider in developing this ‘new’ way:

  • Wholesale revamping of their credit & risk management procedures – this is an obvious area of focus and one that will require significant reengineering given the past failures and the changed business model. Once the loan books are ‘cleansed’ and classified and the staff re-skilled, the banks need to move to a more decentralized model to reflect the inevitable increased emphasis on SME business.
  • Reduce costs & outsource non-critical activities – in the new environment the banks must relentlessly prune any unproductive activities and become as efficient as the best companies in other sectors. For non-core activities outsourcing is a proven approach in translating variable costs into a lower fixed overhead. This process, however, must be tightly managed.

Ultimately, execution of these activities becomes the determining factor in success.

Interestingly in their July 2004 report McKinsey used the example of my former employer, Mellon Bank, as an example of a bank that successfully executed a turnaround in its fortunes after uncovering major problems in its loan portfolio in the late eighties, a few years ahead of the general US banking crisis.

“We are at an extraordinary period of history.
It is a time of crisis and unprecedented uncertainty,
even fear; but it is also a time of opportunity for
change and profound transformation.”
Klaus Schwab, Chairman, World
Economic Forum 2009

Creating Artificial Stimulus

by Micheal O Callarain on / 10 Comments

Category: Economy, Finance

Much like the science fiction movies from the 80’s where artificial intelligence becomes self aware and threatens the world, artificial stimulus threatens Ireland’s recovery in much the same fashion.

Over the last few months Ireland’s baking sectors have undergone a massive change with the near complete collapse of AIB (Allied Irish Bank), an entity that the government has sunk an additional 3.7 billion Euros in during the month of December. This activity marked the ever expanding hold that the Irish government has on the banking sector, and is largely being seen as the way to assist the failing economy through recapitalization.

According to the World Economic Forum this is not the fundamental issue facing the struggling nation, a recent release cites the top 3 barriers to doing business in Ireland as:

1. Inadequate Supply of Infrastructure

2. Inefficient government Bureaucracy

3. Inflation

So how does dumping government funds and adding the inefficient government into a free market structure help to drive down inflation or improve infrastructure if the underlying monetary policy does not change, thus freeing up access to capital? What they are trying to do is create the illusion of prosperity through making a gamble with the public’s money and hoping that the perception of strength will inspire investors and governments to place their funds back in an ailing system and raise consumer confidence through pointing to solid cash positions of the banking sector (this is of course accomplished through removing the bad debts through NAMA, and then adding in Euros to strengthen the cash position). It is similar in effect to creating artificial stimulus, and then hoping that it lives and breathes on its own. This is the equivalent of a smoke and mirrors attempt to merely run the phantom perceived value up without increasing the value of the underlying asset, however this sort of activity runs the risk of the newly formed “artificial stimulus” becoming self aware and creating yet another derivative tool of a faith based economy…..similar to the advent of high frequency trading.

If the above challenges are the reality of those entities doing business in Ireland is additional governmental regulation of the nation’s banks the answer to the lack of infrastructure, the complexity of government, or inflation? A perceived value will not raise the value of Irish bond prices, as a savvy investor will see right through the illusion, however the perception will allow investors to run the prices arbitrarily based on faith alone. It is in short a gamble that aims at the perception catching hold and actually becoming the reality through acceptance by the population. The question however that the population must now ask themselves is if NAMA is the right entity to return on their investment in a timeframe adequate to meet the needs of the country. This should be evaluated using the aforementioned challenges as parameters, and a short analysis will identify that selling off bad debt will not move the needle on the top 3 barriers.

Cash flow is just as important in a business as the balance sheet, and if the government buys debts to profit in the long term, there are still short term liabilities that are coming due. Given the outlook for the deficient in the coming year and the GDP of Ireland it is hard to see where the additional revenue will come from with such a high unemployment rate and flat consumer activity forecasted in the coming year. This newly aware artificial stimulus will only move money around the board, draining each transaction little by little until the reality is that the non-value added movement of a false security is seen for what it is, leaving investors with only pennies on the dollar. 

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