Last week I was speaking at a forum on Open Societies in Panama City. My speech covered the key threats and transformational changes in the global financial services. Here are my annotated slides:
Showing posts with label Alternative Banking. Show all posts
Showing posts with label Alternative Banking. Show all posts
Wednesday, February 22, 2017
Wednesday, August 7, 2013
7/8/2013: Sunday Times, July 21, 2013: New Financial Order
Catching up on some of my past articles from the Sunday Times, here's an unedited version from July 21, 2013.
Five years into the Great Recession collapse of Irish domestic investment, underpinned by the unprecedented in history of the EU drop in lending to indigenous enterprises, continues to act as the main force holding back Irish recovery. Despite serious policy efforts to unlock banks lending, especially to the SMEs sector, expanded by the current Government and its predecessor there are many structural reasons as to why a return to the rampant lending and lending-backed investment in this economy remains elusive. After years of waiting for lending to return, we need to shift our policies focus away from attempting to refuel another SMEs credit bubble toward incentivising new forms of capital formation and accelerating the rate of existent debt restructuring in the real economy.
This week, research published by the Bruegel Institute reminded us about the horrors of the Irish credit system collapse. Looking at the outstanding credit to non-financial corporations from September 2008 through April 2013, the researchers found that Irish banking system experienced the largest decline in overall credit of all EU27 states. Ireland's outstanding credit to non-financial companies has fallen more than 50 percent over the period covered in the study, with the second-worst performing economy, Spain coming in with a more benign drop of 30 percent. Bankrupted Greece is in a distant fifth place, having posted a 'mere' 25 percent credit contraction.
Most recent Central Bank data, relating directly to the SMEs lending in Ireland, shows that new lending in Q1 2013 was 41 percent below the Q1 average for 2010-2012, despite the figures showing a slight rise quarter on quarter. Netting out new loans issued for financial intermediation and property, credit extended to SMEs in the first three months of this year was down 11 percent compared to the 2010-2012 average for the same period.
Strikingly, as Irish credit volumes shrunk faster than in any other EU state, interest rates for loans to Irish enterprises under EUR1 million in volume have declined in line with those for the lower credit risk economies. When it can be had, Irish SMEs credit is priced in line with such countries as Denmark, the Netherlands, Sweden and the UK.
On the other hand, SMEs’ demand for loans remains high. In Q2 2013, according to the latest ISME survey, demand for new credit rose to 41 percent from 38 percent a year ago. On average, 48 percent of all companies that applied for funding in the first six months of 2013 were refused credit by the bank, slightly down on 51 percent average rejection rate for 2012.
Good news: demand and refusal rates are starting to move in the opposite directions, just as credit supply is beginning to turn positive. Bad news: all improvements are shallow in nature and are yet to show sustainability over time.
All of this presents us with a paradox: while credit demand is high, both supply of loans and the cost is low. The reason for this is that Irish SMEs and banks are continuing to operate in a highly abnormal environment. Changing this will require reducing a severe debt overhang in the Irish SMEs sector, regulatory changes aimed at improving banks ability and incentives to restructure legacy loans, and a lengthy period of time to heal the overall collapse in SMEs willingness to undertake risky investment.
All indicators suggest that gradual improvements in the credit quality of SMEs are not keeping up with rising demand for loans.
Per ISME data, 12 percent of SMEs that do require bank finance abstain from applying for it; over half of them in fear that making an application can lead to the banks shutting down existent credit facilities. Of those SMEs that do apply, 28 percent saw demands for overdrafts reductions imposed onto them. Over half of the credit requests made but the SMEs were for overdrafts or invoice discounting/factoring.
This largely confirms the findings of our recent research based on the ECB data collected at enterprise level across the euro area. Applied to Ireland, our findings strongly suggested that significant contributor to the decline in credit was due to structural insolvency of SMEs’ balance sheets. These drivers are not being dealt with fast enough at the policy and banks levels to allow for the recovery in private sector investment.
Firstly, Irish SMEs remain heavily exposed to legacy loans secured against or for the purpose of property investment. Back in the early 2008, several investment banks have estimated that up to 90 percent of Irish business sector loans issued from 1998-1999 through 2006-2007 were exposed to the risk of collapse in property valuations. The main outcome of this is a wave of bankruptcies that is still consuming the sector. High debt levels tied to property loans mean that over one half of all Irish SMEs loans are currently in arrears, based on the Central Bank estimates. Referencing dynamics in residential buy-to-let markets (representing household side of the investment markets) and new lending data for SMEs, my own estimates suggest that closer to 70 percent of all SMEs loans still outstanding are either in arrears or at risk of failing.
However, even for the enterprises that survived the immediate drop in asset prices, property values decline has meant reduced borrowing capacity for years to come, greater propensity to avoid seeking new credit, and weakened existent production base. Behavioural studies suggest that SMEs hit by the property valuations declines, in contrast to newer enterprises formed after the property bust, will tend to reduce their future borrowings, even if they are given access to new finance. This applies also to companies that have completed successful debt restructuring. In addition, as SMEs lower their investment in new equipment, product R&D, and strategic and operational improvements, they reduce their future competitiveness and profit margins.
Secondly, Irish SMEs are operating in the environment of malfunctioning debt restructuring mechanism.
In a normal recession, banks hold sufficient capital to actively engage with SMEs in restructuring their debts. At the same time, short time span of a normal recession means that a bulk of businesses liquidations extend into the period of early economic recovery. Sales of distressed business assets, in normal recession, often take place in rising markets.
In a severe balance sheet recession, like that experienced today in Ireland, banks transfer costs of keeping the non-performing enterprises alive to other clients. One sign of this is that charges on short-term loans, often used to cover balance sheet pressures, tend to rise slower than charges on larger, capital investment-linked loans. From the bottom of the interest rate cycle through May 2013, cost of new credit for loans up to EUR1 million based on floating rate rose 33 percent. Cost of loans over EUR1 million with over 1 year fixation rose 87 percent. Such cost transfers harm better companies' ability to raise investment, while slowing down the rate at which the insolvency works through to weed out the unsustainable businesses. End game - delayed resolution of the debt crisis at the expense of suppressed capital investment and growth.
All of the above helps explain why less than a third of all Irish SMEs that do apply for credit from their bank end up drawing down any loans. But the above also suggests the policy direction that should be taken in trying to increase domestic capital formation while continuing to pursue system-wide deleveraging.
Unlocking investment requires, first and foremost, finding new sources for funding business expansion, distinct from bank lending. Such sources include equity financing and direct borrowing. The Government needs to develop incentives for equity investment in, and peer-to-peer and public-to-business lending to Irish SMEs.
To expand the pool of potential investors, we need to open these platforms and Irish investment services to international investors and institutions. Government re-insurance scheme for exports finance can be a good step forward in making Irish SMEs more attractive to foreign investors and freeing up some operating capital for growth. Another similar measure would involve more state co-investment in existent enterprises (as opposed to new ventures) based on their ability to generate intellectual property, associated with new products and services development.
While stimulating new forms of SME funding, Ireland also needs to accelerate the process of business insolvency resolution. This will require two major changes in the way our insolvency process is regulated.
We need to recognize the necessity for allowing banks to treat business equity as lower risk asset when restructuring legacy loans for sustainable enterprises. This can help increase debt-for-equity swaps between lenders and borrowers. In return, such swaps can allow banks to use their limited resources on deleveraging out of unsustainable loans. We also need to revise our targets for banks deleveraging, potentially extending the period over which the pillar banks are required to reduce their loans exposures and increase allowance for SMEs loans to be held by the banks. To reduce overall systemic risks, we can require banks to put their restructured SMEs loans through more rigorous stress-testing.
The second major change is to relax the constraints on entrepreneurship and professional standing for business owners going through bankruptcy proceedings. This will allow for a quicker return of past entrepreneurs to new ventures and will aid SME sector deleveraging.
All of the research on SME credit in the Euro area and Ireland shows that both supply and demand drivers are responsible for the collapse of investment during the current crisis. Instead of attempting to rebuild the legacy systems based on unsustainable lending, we need to think outside the box to identify new ways for funding productive investment. Both banking and the SME sector will require significant changes to deliver on this.
Box-out:
Largely ignored by the Irish media headlines, there is a new longer-term threat to our economy emerging from the EU's penchant for policies harmonisation. This week, at the talks in Vilnius, Lithuania, EU officials were discussing the need for pan-European regulation of data protection. In part, these talks were driven by the EU-US Free Trade Agreement negotiations and the recent scandal relating to e-spying. However, the main impetus for harmonising European regulations is the emerging imbalances in the ICT services investment across the EU. Ireland’s EU partners, especially Germany and France, are unhappy that our, allegedly, light-touch regulations act as a major attractor for foreign direct investment in ICT sector, ‘stealing’ jobs from Germany and tax revenues from France. The risks implied by harmonisation of EU regulations in this area are of significant economic concern. It is, perhaps, ironic that data protection regulations or their potential harmonisation did not make it into the ESRI's latest paper on ICT-related FDI, titled "Boosting Foreign Direct Investment in the Information and Communication Technologies Sector: What Works?" published this week. Foreign providers of ICT services in Ireland dominate the sub-sector which acts as the sole source of growth in Ireland from 2008 through today. Between Q1 2008 through Q1 2013, Irish ICT services credit to the current account rose from EUR5.86 billion to EUR9.35 billion. In Q1 2013, ICT services trade surplus exceeded our economy’s total external balance by 37 percent. Squeeze this sector through regulatory harmonisation and Ireland’s latest recession will look like a walk in a park, while our debt sustainability risks will go back to 2011 levels.
Five years into the Great Recession collapse of Irish domestic investment, underpinned by the unprecedented in history of the EU drop in lending to indigenous enterprises, continues to act as the main force holding back Irish recovery. Despite serious policy efforts to unlock banks lending, especially to the SMEs sector, expanded by the current Government and its predecessor there are many structural reasons as to why a return to the rampant lending and lending-backed investment in this economy remains elusive. After years of waiting for lending to return, we need to shift our policies focus away from attempting to refuel another SMEs credit bubble toward incentivising new forms of capital formation and accelerating the rate of existent debt restructuring in the real economy.
This week, research published by the Bruegel Institute reminded us about the horrors of the Irish credit system collapse. Looking at the outstanding credit to non-financial corporations from September 2008 through April 2013, the researchers found that Irish banking system experienced the largest decline in overall credit of all EU27 states. Ireland's outstanding credit to non-financial companies has fallen more than 50 percent over the period covered in the study, with the second-worst performing economy, Spain coming in with a more benign drop of 30 percent. Bankrupted Greece is in a distant fifth place, having posted a 'mere' 25 percent credit contraction.
Most recent Central Bank data, relating directly to the SMEs lending in Ireland, shows that new lending in Q1 2013 was 41 percent below the Q1 average for 2010-2012, despite the figures showing a slight rise quarter on quarter. Netting out new loans issued for financial intermediation and property, credit extended to SMEs in the first three months of this year was down 11 percent compared to the 2010-2012 average for the same period.
Strikingly, as Irish credit volumes shrunk faster than in any other EU state, interest rates for loans to Irish enterprises under EUR1 million in volume have declined in line with those for the lower credit risk economies. When it can be had, Irish SMEs credit is priced in line with such countries as Denmark, the Netherlands, Sweden and the UK.
On the other hand, SMEs’ demand for loans remains high. In Q2 2013, according to the latest ISME survey, demand for new credit rose to 41 percent from 38 percent a year ago. On average, 48 percent of all companies that applied for funding in the first six months of 2013 were refused credit by the bank, slightly down on 51 percent average rejection rate for 2012.
Good news: demand and refusal rates are starting to move in the opposite directions, just as credit supply is beginning to turn positive. Bad news: all improvements are shallow in nature and are yet to show sustainability over time.
All of this presents us with a paradox: while credit demand is high, both supply of loans and the cost is low. The reason for this is that Irish SMEs and banks are continuing to operate in a highly abnormal environment. Changing this will require reducing a severe debt overhang in the Irish SMEs sector, regulatory changes aimed at improving banks ability and incentives to restructure legacy loans, and a lengthy period of time to heal the overall collapse in SMEs willingness to undertake risky investment.
All indicators suggest that gradual improvements in the credit quality of SMEs are not keeping up with rising demand for loans.
Per ISME data, 12 percent of SMEs that do require bank finance abstain from applying for it; over half of them in fear that making an application can lead to the banks shutting down existent credit facilities. Of those SMEs that do apply, 28 percent saw demands for overdrafts reductions imposed onto them. Over half of the credit requests made but the SMEs were for overdrafts or invoice discounting/factoring.
This largely confirms the findings of our recent research based on the ECB data collected at enterprise level across the euro area. Applied to Ireland, our findings strongly suggested that significant contributor to the decline in credit was due to structural insolvency of SMEs’ balance sheets. These drivers are not being dealt with fast enough at the policy and banks levels to allow for the recovery in private sector investment.
Firstly, Irish SMEs remain heavily exposed to legacy loans secured against or for the purpose of property investment. Back in the early 2008, several investment banks have estimated that up to 90 percent of Irish business sector loans issued from 1998-1999 through 2006-2007 were exposed to the risk of collapse in property valuations. The main outcome of this is a wave of bankruptcies that is still consuming the sector. High debt levels tied to property loans mean that over one half of all Irish SMEs loans are currently in arrears, based on the Central Bank estimates. Referencing dynamics in residential buy-to-let markets (representing household side of the investment markets) and new lending data for SMEs, my own estimates suggest that closer to 70 percent of all SMEs loans still outstanding are either in arrears or at risk of failing.
However, even for the enterprises that survived the immediate drop in asset prices, property values decline has meant reduced borrowing capacity for years to come, greater propensity to avoid seeking new credit, and weakened existent production base. Behavioural studies suggest that SMEs hit by the property valuations declines, in contrast to newer enterprises formed after the property bust, will tend to reduce their future borrowings, even if they are given access to new finance. This applies also to companies that have completed successful debt restructuring. In addition, as SMEs lower their investment in new equipment, product R&D, and strategic and operational improvements, they reduce their future competitiveness and profit margins.
Secondly, Irish SMEs are operating in the environment of malfunctioning debt restructuring mechanism.
In a normal recession, banks hold sufficient capital to actively engage with SMEs in restructuring their debts. At the same time, short time span of a normal recession means that a bulk of businesses liquidations extend into the period of early economic recovery. Sales of distressed business assets, in normal recession, often take place in rising markets.
In a severe balance sheet recession, like that experienced today in Ireland, banks transfer costs of keeping the non-performing enterprises alive to other clients. One sign of this is that charges on short-term loans, often used to cover balance sheet pressures, tend to rise slower than charges on larger, capital investment-linked loans. From the bottom of the interest rate cycle through May 2013, cost of new credit for loans up to EUR1 million based on floating rate rose 33 percent. Cost of loans over EUR1 million with over 1 year fixation rose 87 percent. Such cost transfers harm better companies' ability to raise investment, while slowing down the rate at which the insolvency works through to weed out the unsustainable businesses. End game - delayed resolution of the debt crisis at the expense of suppressed capital investment and growth.
All of the above helps explain why less than a third of all Irish SMEs that do apply for credit from their bank end up drawing down any loans. But the above also suggests the policy direction that should be taken in trying to increase domestic capital formation while continuing to pursue system-wide deleveraging.
Unlocking investment requires, first and foremost, finding new sources for funding business expansion, distinct from bank lending. Such sources include equity financing and direct borrowing. The Government needs to develop incentives for equity investment in, and peer-to-peer and public-to-business lending to Irish SMEs.
To expand the pool of potential investors, we need to open these platforms and Irish investment services to international investors and institutions. Government re-insurance scheme for exports finance can be a good step forward in making Irish SMEs more attractive to foreign investors and freeing up some operating capital for growth. Another similar measure would involve more state co-investment in existent enterprises (as opposed to new ventures) based on their ability to generate intellectual property, associated with new products and services development.
While stimulating new forms of SME funding, Ireland also needs to accelerate the process of business insolvency resolution. This will require two major changes in the way our insolvency process is regulated.
We need to recognize the necessity for allowing banks to treat business equity as lower risk asset when restructuring legacy loans for sustainable enterprises. This can help increase debt-for-equity swaps between lenders and borrowers. In return, such swaps can allow banks to use their limited resources on deleveraging out of unsustainable loans. We also need to revise our targets for banks deleveraging, potentially extending the period over which the pillar banks are required to reduce their loans exposures and increase allowance for SMEs loans to be held by the banks. To reduce overall systemic risks, we can require banks to put their restructured SMEs loans through more rigorous stress-testing.
The second major change is to relax the constraints on entrepreneurship and professional standing for business owners going through bankruptcy proceedings. This will allow for a quicker return of past entrepreneurs to new ventures and will aid SME sector deleveraging.
All of the research on SME credit in the Euro area and Ireland shows that both supply and demand drivers are responsible for the collapse of investment during the current crisis. Instead of attempting to rebuild the legacy systems based on unsustainable lending, we need to think outside the box to identify new ways for funding productive investment. Both banking and the SME sector will require significant changes to deliver on this.
Box-out:
Largely ignored by the Irish media headlines, there is a new longer-term threat to our economy emerging from the EU's penchant for policies harmonisation. This week, at the talks in Vilnius, Lithuania, EU officials were discussing the need for pan-European regulation of data protection. In part, these talks were driven by the EU-US Free Trade Agreement negotiations and the recent scandal relating to e-spying. However, the main impetus for harmonising European regulations is the emerging imbalances in the ICT services investment across the EU. Ireland’s EU partners, especially Germany and France, are unhappy that our, allegedly, light-touch regulations act as a major attractor for foreign direct investment in ICT sector, ‘stealing’ jobs from Germany and tax revenues from France. The risks implied by harmonisation of EU regulations in this area are of significant economic concern. It is, perhaps, ironic that data protection regulations or their potential harmonisation did not make it into the ESRI's latest paper on ICT-related FDI, titled "Boosting Foreign Direct Investment in the Information and Communication Technologies Sector: What Works?" published this week. Foreign providers of ICT services in Ireland dominate the sub-sector which acts as the sole source of growth in Ireland from 2008 through today. Between Q1 2008 through Q1 2013, Irish ICT services credit to the current account rose from EUR5.86 billion to EUR9.35 billion. In Q1 2013, ICT services trade surplus exceeded our economy’s total external balance by 37 percent. Squeeze this sector through regulatory harmonisation and Ireland’s latest recession will look like a walk in a park, while our debt sustainability risks will go back to 2011 levels.
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