Monday, September 26, 2011

Overdraft woes put more pressure on already hard hit businesses


Accessing affordable credit on favourable terms is almost impossible for all but the best small business borrowers. Many are struggling with credit restrictions as their bankers reign in on years of loose lending.  

SME’s have significant challenges. Increasing delays in receiving payments when added to unsold stock has resulted in an endemic shortage of working capital and decrease in cash and liquidity. Rising defaults and insolvencies are leaving many without a key supplier and uncollectable bad debts. A drastic drop in demand for goods and services has been amplified as Government’s austerity programme undermined consumer confidence.

In a recessionary environment it is tremendously difficult for small businesses to grow their way out of trouble. And in a creditless environment, many viable businesses have no hope at all of surviving. Most cannot downsize as they are already small. With limited financing options they are heavily dependent on bank credit. Overdrafts, the principal small business working capital finance tool, are being rigorously re-assessed by bankers anxious to limit their exposure in a recessionary economy.

In many cases businesses are being forced to refinance all or part of their overdrafts as term loans. While it’s always been prudent banking practice to require businesses to fund the long term working capital element of their cash flows through term lending, today, this policy has become a risk limitation tool to manage out boom-time hardcore debts built up in overdraft facilities.

Bankers have two problems. The first relates to allocating scarce capital to unused overdraft limits. They will be inclined to roll back on limits to better manage their capital. The second relates to SME lending risks which are continuing to worsen. From experience, bankers know that as most small business owners are not financially sophisticated, they will gamble for resurrection by using overdrafts to fund their bad debts. All too often by the time the overdraft is called in, the business is already bust. To counteract this problem bankers insist that businesses convert hard-core overdraft debt into term loans and reduce their overdraft limit. The danger is that aggressive overdraft hardcore management by bankers will undermine viable businesses.

A recent story of AIB insisting on businesses having to match their overdraft limits with cash deposits – termed compensating balances, was denied by the bank which said it was not its lending policy to require compensating deposit balances for business overdrafts. When asked if it was reducing outstanding limits to better manage its capital, an AIB spokesperson said “reducing the number of outstanding limits is not at all part of the motivation or the decision making process when converting overdrafts to term loans.” He explained, “when a hardcore builds up in an overdraft, its standard practice for the bank and for the customer that the overdraft or a portion of it be converted to a structured term loan to better facilitate the repayment of borrowings”

While banks may not have a formal policy of requiring overdraft compensating balances, it’s likely that when reviewing and renewing overdraft limits, their managers are pressing businesses to place money on deposit with them.

As banks have responded by toughening up on credit terms, business trade bodies have been pleading for a range of responsive measures from the Government since 2008. The Government’s response has been to insist banks lend money to small business and to establish the credit review office to second guess banker’s unfavorable loan decisions. It’s fair to say that its response has been about as useful as a foot pump on the Titanic.

Access to financing has always been one of the most significant challenges for SME establishment, growth and survival. Since 2008, the Governments’ meek response to a funding crisis facing small business contrasts starkly with small business support systems introduced in other countries. Elsewhere, countries have implemented extensive measures for SME’s, including credit guarantee schemes designed to allow banks to make good loans to good borrowers. 

Other measures include export credit guarantees, credit mediators who mediate between businesses and their bankers, favourable tax regimes such as accelerated depreciation schedules, employment subsidies, faster payment by state and public bodies and payment forbearance in “profit insensitive taxes” paid regardless of whether or not a business is making a profit. These measures target three areas: stimulating demand for goods and services, preventing depletion of working capital and liquidity and helping to maintain capital investment levels.

Months into a new administration, we have yet to see a cohesive policy response to the immediate and long term funding problems faced by viable small businesses. The only reference from this Government so far has been a suggestion that something may be done for viable businesses that are threatened by their owner’s boom-time property gambles. While a job protection measure, it falls well short of the imaginative response needed if small businesses are to be an engine of economic recovery.

A version of this article appeared in the Irish Examiner, Business Section, Monday 26th September 2011.

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