Securing medium-term funding – businesses should act now

By | May 28, 2010

Financial graphVince Cable says the banks must get lending, as ‘they have been accumulating reserve capital beyond their requirements’.

Businesses should be wary. Don’t think this means funding is finally about to be released. In fact, my recommendation would be to make sure you do everything possible to secure medium-term funding requirements now.

While credit conditions have eased somewhat in recent months, businesses are still repaying more to banks than they are receiving in new credit.

Net funding of UK businesses (£bn)

 

Net funding of UK businesses (£bn)

Net funding of UK businesses (£bn)

 

Quarterly totals. Source: http://www.bankofengland.co.uk/publications/other/monetary/LendingToUKBusinessesMay2010.xls

This figure clearly reveals a decline in funding in the first quarter of 2010 despite the fact that the economy has been displaying clear signs of improved stability over the last year. The most recent data confirms this short-term downward trend. In April 2010, mortgage lending was 12 per cent less than in March and the worst figure for the month for a decade, according to the Council of Mortgage Lenders. In March this year, the Bank of England found that corporate lending was nine per cent less than in February, with borrowing at the lowest levels for more than a decade.

As the graph above shows, at the peak of the boom in 2007, banks were net lending about £40bn a quarter to UK businesses. The point of concern is that the banks face three other major exposures of this order of magnitude at the moment.

1 £200bn bank bail-out

UK banks were bailed out to a tune of £200bn, in total, by our government at the end of 2008/early 2009 through initiatives such as the Special Liquidity and Credit Guarantee Schemes. The timetable is for these schemes to start to be unwound from the middle of next year and the Governor of the Bank of England has made it clear that this will not be extended. As Michael Coogan, director general of the Council for Mortgage Lenders has been recently quoted as saying, “Unless funding issues are addressed, any recovery in lending may well be curtailed as the repayment date on the support schemes gets closer.”

2 £150+bn Southern European lending

At present, there is the distinct possibility that the governments of Greece, and some other Southern European countries, may default on their sovereign debt. For example, at today’s rates, an investor would need to pay over 7 per cent of the nominal value to insure Greek sovereign debt against default over the next five years.  Much of this debt is held by banks in Europe with UK institutions alone having lent about £150bn to the PIGS nations (the acronym given to what are seen as the weak economies in Europe – Portugal, Italy, Greece and Spain). Should default occur, this would put additional pressure on the banking system and risk a double-dip banking crisis in Europe.

3 Crowding out

The UK government is going to need to borrow over £100bn a year from financial markets for the foreseeable future to fund its budget deficit. This is an historically unprecedented number. In 2009, finding investors for this debt was considerably eased by the Quantitative Easing (QE) programme, where the Bank of England bought existing UK Government debt back from financial institutions and thus boosted their liquidity. However, QE has now finished – at least for the time being – meaning that the Government is taking considerable amounts of net money from the markets.

While it would be great if Chinese, Kuwaiti or other foreign investors would come into the market to take up this debt, the evidence suggests they are not doing so. Therefore, it will fall on British institutions, including the banks, to provide this funding. The Government may facilitate this through the regulatory process, insisting that financial institutions need to strengthen their balance sheets by adding more secure assets – such as gilts.

If British banks and other investors are being pressured to fund the Government, then there will be less availability of capital to put into the corporate or mortgage sectors.

Given these three stresses on bank liquidity in the UK, it looks as if it may be a long haul before there is anything like the availability of capital in the UK economy to get businesses growing again.

About Mark Freeman

Mark joined the School of Management in 2006, following previous full-time academic appointments at the Exeter Centre for Finance and Investment (University of Exeter) and the University of Warwick. He has held visiting academic positions at the Kellogg Graduate School of Management (Northwestern University), the University of California, Irvine, and the University of Technology, Sydney.

Before becoming an academic, he worked as an equity research analyst specialising in the brewing and distilling industries for stockbrokers Savory Milln and James Capel, in London. He also has corporate finance experience with United Distillers in Scotland.

Specialties: Economics of climate change, Long term funding of nuclear power, Pension funds - long term deficits

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