Tag Archives: SME

Banks, SMEs and relationship banking

BoI Survey talk UpdatedThe last few weeks have seen the launch of two reports on SME Finance. One was the now regular Department of Finance report on credit conditions, the other a Bank of Ireland report on the financial situation of tech orientated SME’s, this drawing in large part on work conducted by a PhD student under my supervision. I launched the latter – my speaking notes are here BoI Survey talk Updated :   and the report here Bank_of _Ireland_ Technology_Research_Embargo. Overall the picture is, as always, mixed.
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Why the rush to replace Universities with Innoversities…?

Ireland, or at least the government, is in the grip of a frenzy around entrepreneurship. From local government, through the higher education system, to the highest in the land, hardly a day goes by without some new band jumping on the wagon. We are being flogged with the mantra that we must start up, become entrepreneurs, be self-employed, yadda yadda yadda. It’s a diversion of resources, built around a self-perpetuating meme. The SME sector is really important, in Ireland and in Europe. In Europe, as of 2012, SMEs accounted for over 99% of all companies, employing just under 90m people. They account for 66% of total employment and for about 58% of total output.  However, when we think of SME’s in Ireland we think of small and medium-sized companies. The SME definition is companies with less than 250 employees, €50m in total turnover. This is by Irish standards a fairly substantial enterprise. In Ireland, SME account for 68% of total employment. Thus, it makes sense, to some extent, to ensure that SMEs as a sector are in rude health. What it may not make sense to do is to pour more and more scarce resources into creating startups and micro enterprises, in pursuit of a problem that doesn’t exist.

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In Search of the Celtic Gazelle.

gazelleThis is a version of a column published in the Irish Examiner on 9 November 2013. When Deng XiaoPeng was in his younger days, in 1961, he uttered his most famous aphorism “It doesn’t matter whether it’s a white cat or a black, I think; a cat that catches mice is a good cat”. This presaged his pragmatic approach to economic management which he eventually put in place when he assumed power. We need something similar in relation to employment, in Europe and in Ireland.We need to create jobs..lots of jobs.However, the menagerie that we need to think about lies perhaps not in the feline species but amongst herbivores. We have had a Celtic Tiger – now we seem to want to look at becoming the Celtic Gazelle

mousephantFirms, in the entrepreneurial literature, can be divided into Mice (small established firms which are unlikely/unable to grow), Elephants (the large established companies) and gazelles (small companies with potential). Much Irish economic policy appears to be about fostering the latter. The ostensible rationale is that these companies create a large proportion of new jobs.  This has been known for 40 years. Recent central bank of Ireland research confirms that for Ireland. Small firms make up about 70% of the Irish firm universe but employ only approx. 14% of the relevant employment universe.  The same research also indicates that foreign owned companies (in effect , multinational branches) have a consistently higher job creation rate than Irish owned across all size categories.  This is a persistent finding in Irish job creation literature.  They also find that small firms tend to be very fast growing. The takeaway might be that we want therefore more small firms which tend to be young which leads to a need for more startups.

Screen shot 2013-11-07 at 11.17.36However, that is not quite the issue : in the small firm literature it is perhaps more useful to look at age of firms than only at size.  Firms start, but they also stop.  There It is also important to not conflate the issues of innovation and entrepreneurship. For a firm, large or small, to remain in business long-term it is important that it be innovative in its processes.  Entrepreneurship however is important when the company is starting up. The characteristics of an innovative manager and an entrepreneurial one are of necessity quite different.There is little doubt that an industrial policy, such as we have, which is now geared heavily towards the cult of startups, can show significant short-term effects in firm creation and job creation.  Shortterm is best perhaps seen as “six months or so less than the time to the next general election” The issue is not that – the issue is how sustainable is this? Do these fast-growing SME’s, which appear in the newspapers and on the radio each morning, with impressive growth over two three or five years, actually sustain this?  Increasingly the answer is that they may not.  We note from the central bank study that there is an overwhelming likelihood of small firms staying small, and large firms staying large.

Hare and tortoiseA recent Danish study looked at fast-growing firms, gazelles, and their long-term survival and employment creation. It found that these firms could not sustain. In fact they found a negative relationship between survival and job creation in the medium term and how fast the company grew in its first five years. This is classic hare and tortoise ourcomes. This they attribute to the creation of an organizational culture that  focuses on outcome and not enough on process. In that regard some government investment into the organizational and managerial skills might reap rewards. It is striking that Science Foundation Ireland has extended its ambit towards innovation in service and manufacturing process innovation, which is welcome. However, there remains a gap in targeted support for organizational and managerial competence and skill building

marketingdemotivatorOther research also suggests that looking at startups to power employment is likely to give only partial success. US research indicates that it is firms with greater than 20 employees or greater than 500 that generate the great bulk of medium term employment growth.  Research from Austria suggests that policies focused on increasing the lifespan of companies might be more advantageous, although these tend to also reduce the number of gazelles. Swedish research also casts doubt on gazelle growing : it might be better to focus on existing companies that are stymied in growth opportunities than focusing on fastgrowing new companies.  This is also found in very recent Finnish focused research, as well as for Canada. Finally a broad survey of the research suggests that gazelles can be found across all size and age categories but crucially the biggest impact on employment comes from larger firms that manage to become gazelles.This research should give us concern. We have a banking system that is  broken and incapable of giving credit to SME’s , when the M part is evidentially crucial. We have government and media obsessed with small scale high tech “sexy” startups. We have a push to make universities and institutes of technology into polytunnels for entrepreneurs. In an environment where less than half of companies founded last beyond five years we need to focus less on startups and more on sustaining companies. Sustainability comes from innovation excellence not entrepreneurial excellence, it involves organizational and financial and managerial skill enhancement and requires a long-term aim to make less S and more M in the SME sector. This is duller stuff – there are fewer media appearances and fewer job announcements. Dull it may be but it is vital

Irish Banks : Arrears, Deposits, Bail-in and Interest Rate Editon

This is an edited and extended version of a column in The Irish Examiner 26 October 2013

There is a great book on marketing titled “the long tail” , which stresses that instead of trying to hit millions of customers at once its perhaps better to do millions of niches. Replete with examples it was and remains a deserved hit. The long tail refers to the distribution of something – a large bulk at one end quickly trailing off to smaller numbers but which go on for a long time. Another word for this is skewness. In very many skewed distributions it is common for the total amount in the long tail to be equal to or greater than the amount in the bulk. Another way of thinking of this is a power law. Many many things have been found to follow power laws – terrorism, population of cities, bibliometrics, income distribution… theres no reason to think Irish bank losses are different.

download (1)The long tail approach is worth considering as we move into the sixth year of this crisis.  Having dealt with the massive mess of the commercial property and developers loans via hiving them off to NAMA (which has yet to “get credit flowing” as its cheerleaders in the then government and some still prominent stockbrokers trumpeted) , the long tail of the mortgage and SME loans continue to erode the banks. We are moving down the tail with the average loss getting smaller but there are an awful lot of them. Today I spoke to a SME owner who runs a small distribution business. He had settled with a bank for a loan taken out in 2006 which resulted in the bank taking a loss of just under €1m. The business is still going, much reduced but “ticking over nicely”. This is as good as it gets – a viable business remains. Many many SME loans are for larger amounts and the banks will take a larger hit as there is nothing left. I think of someone  I know who purchased a house in 2006 for €450k, interest only of course, in a  not very fashionable holiday area, where similar homes are selling at €150k on a good day. These are the long tail and they are wagging the dogs of our banks as the banks chase them round in a circle.

Basel-IIIAt present Irish banks are well capitalized. Some might say that in a classic overreaction to the lack of adequate capital buffers in the past they are over capitalized. Bank capital is a two edged sword. On the one hand the more capital they have the greater a buffer exists to absorb losses. On the other, as capital is measured as a percentage of assets the more capital is required then all things considered the smaller will be the assets. A bank that has a 10% capital ratio will be able to make more loans (assets) than one that is required to hold a 15% ratio. The ECB has recently announced that it will conduct another round of stress tests. These are required, in essence, so that the final set of capital injections will be made prior to the ECB taking over full control of regulation. The political reality is that this step, a necessary requirement for a proper banking union, will require that individual states make or supervise any capital injections. In a banking union this will be the responsibility of the union, and thus the German taxpayer might be on the hook. But not this last time.

gpyugoWe have known for some time that the Irish banks will require additional capital. The state of the mortgage book is bad but the state of the SME loan book is also dire. Earlier this year we found out that  50% of the SME loan book was in distress.  There is a total of €70b in SME lending, of which an astounding €30b is still outstanding to real estate. A multibillion loss is an absolute certainty.   On the mortgages we have similar. The question that should raise its head is : who bears these losses. Traditionally the order of losses was deemed to be shareholders -> junior bondholders -> deposits and senior bonds. The taxpayer might then step in and recapitalize if the bank was deemed to be needed.  So in the Irish case 2008 saw some but not all junior bondholders and almost all equity destroyed, but the system balked at that and so in stepped Paddy with his chequebook. And we know how that ended. We saw in Cyrpus, and indeed have seen in the liquidation of IBRC that depositors can and in future will be “bailed in”. This is fine and dandy if all other sources of capital have been burned through. The problem is that recent statements by Mario Draghi suggest that bondholders might be spared in future, for fear that once burned they might not return. In other words the sovereign would be required to make a decision as to whether they would absorb losses or instead force bailins on depositors. There is zero willingness for the Irish state to add more taxpayer money into the banks. Thus the question becomes: do the banks hae sufficient buffers in place to absorb losses before the question of depositors comes into play?

hqdefaultOn a macro level they are good. AIB has shareholders funds of c 10b, BOI of 8b and PTSB 2.4b.  In the case of PTSB and AIB much of these shareholder funds are in fact state funds, so any erosion of these is an erosion of taxpayer funds. The problem is that as we noted they are required to hold funds at a certain level. This level is higher than the European requirements. Thus as losses get booked the banks will have to either raise additional funds. This, in sufficient amounts, is I submit unlikely. While they have had some success in raising limited amounts these have either been expensive or have required significant security. In addition, the banks face rollovers of existing issued debt. Bank of Ireland will need to roll over or pay off bonds of 9.5b in 2014-2015, AIB 7.5b and PTSB 5b n the same period. This will tax them significantly. If they face a requirement to otherwise increase capital from losses that will make the job that much more difficult. A large part of the outstanding bonds are senior notes, some 7b. A large part of the remaining is covered or asset backed. Only some 5b or so across the banks, mainly in Bank of Ireland, are unsecured or subordinated. Bank of Ireland has the largest “burnable” buffer but is the one least likely to require it. AIB has very little unsecured debt and less than 4b senior debt. We have seen that even the mention of senior debt being burned, where legally possible, has caused significant negative market reaction. Thus where there is no taxpayer backstop and either no bondholders or no willingness to burn them, inevitably deposits must come into play. In that context depositors should seek a higher rate than they are at present getting.

browseChartThe chart shows the deposit rate on new deposits for an agreed maturity, Ireland v Germany. Deposits that were ten years ago seen as close to riskless as it is possible to be are no longer so perceived. The difference between Irish and German deposits is not, I suggest, sufficient to reward for the relative risk differential. Although small, the risk of depositor bailin in Ireland is many many times larger than that in Germany. These risks are the worst sort- small probability large outcome risk. It is time that the banks begun to remunerate depositors  appropriately for the risk, small that it is, that they are being asked to bear.  We need to move away from a banking system that is dependent in large part on loan capital towards one that is dependent on deposits. In fact, in the last week we have seen the situation worsen. The increase in DIRT means that deposits are now paying less than the already paltry levels. Combined with the loss of ACC , closing after 86 years, this further erodes competition, even if ACC was a small player. Expect pressure on interest rates to be downward, relatively speaking, on deposits. Which are now risk capital and in the firing line.

Cypriot SME Cash Holdings and the “corralito”

Data on these are hard to get. The best and its not very good, is the Amadeus Database by Bureau Van Djik. 

Looking throught this this AM, I extracted the “cash and cash equivalent” balance sheet item for 2011 (the latest year for which there are accounts) for a set of Cypriot companies. These were non-financial non-state corporations, independent (as in not subsidiaries) and SME’s as per the european classification. 

Remember that all deposits up to 100k are safe; remember also that even the most financiallly unaware Cypriot SME must have been thinking about the safety of their cash since 2011.

Average Cash – €487 ; Median Cash €66k 

A lot of Cypriot SME’s if the distribution is similar now as it was then (which is imho still probable – who would think that the bank deposits would be in play, right?) will be badly hurt. 

Remember : “its all hot russian money”….

The Banking Union: what’s in it for Ireland?

This is an expanded version of an OpEd in the Irish Examiner published 15 December 2012

Group Chief Executive of the Bank Of Ireland, Boucher, reacts during an interview with Reuters at the company's head office in Dublin, IrelandThe new banking union proposals that are now emerging from the wreckage of the European economy are to be given a (very) cautious welcome. Without going the whole Naomi Klein “shock doctrine” route, its very clear that once again this is a win for (mainly german) banking interests. They for one have not wasted a good crisis, unlike our hapless crew of permanent and transitory governments. Banks have walked away scot free, in essence, from the calamitous decisions they have made. In Ireland, faced with a government as weak as water they essentially bluffed and buffaloed a hapless crew of inepts into socialising the losses. Anybody who think that senior bank management have learned their lesson of humility need only look at the truculent faces when the elected representatives dare question their remuneration.

1-leg-stool1A banking union required three essential elements: a common supervisor, a common system of deposit insurance or assurance, and a common method to resolve problems. What we have here is the first, and its as good a place to start as any. But without the others its a onelegged stool. The power in European banking has now shifted decisively to Frankfurt – already building an new towerblock (for a cost of over a billion euro…) the ECB will soon need more space. As presently proposed the effect of the new regulator will be to shift regulatory control of AIB, IBRC and BOI to Frankfurt. What exactly that will mean for the newly beefed up regulators office in Dame Street (the beefing up requiring that it move to the IBRC shell – very apt) is unclear. Will staff move to Frankfurt or more probably will it be a remote operation?

Two issues emergent from this require us here to think long and hard. These are the future funding of SMEs and the future of those vile promissory notes

On SME funding the Irish banks are in a bind. They need to continue to delever, and the only way to do that is to progressively increase the deposit base (costly) and/or reduce outstanding loans. In particular, reducing loans will be done while also shifting the balance of loans away from riskier towards less risky ventures. Lending to SME’s is inherently more risky than to more established sectors and ventures. The easiest venture at present is to obtain cheap money from the ECB and purchase Irish government bonds, a carry trade as it is known, reaping a handsome profit for the banks and incrementally driving up the price and down the yield on these bonds yielding a handsome political dividend for the government. Evidence from the ECB biannual survey on access to finance that along with Greece Irish SME’s are the most likely to be discouraged from applying for credit. Although only around 10%, this is unfortunate – discouraged borrowers may be borrowers that have excellent prospects but feel that there is no point seeking a loan. Since March 2010, when the data series begins, excluding property and financial services related lending, lending to the SME sector has fallen by 24%, while in the overall economy it has fallen by 22%. Within the SME sector lending to property and financial services related activity has risen by 30%. Its hard to see how this is justified given the job creation engine that the SME sector can be. As banks regulatory oversight moves more and more remote it is likely that the existing centralization of lending decisions at HQ will intensify. It is reasonable to assume that local managers of banks are more likely to be at least approachable by local SMEs seeking finance. If we wish to reduce discouragement in applicants we need to be very nimble in negotiating the parameters of this new regulatory regime. It’s a good job we have a history of nimble wily negotiators with the ECB….




















IOU_1The creation of the new regulatory framework was a quid pro quo for the establishement of the new ESM lending framework. This will lend to banks for new capital needs, finally breaking the linkage between the soverrign and the banking sector. However, this is of little use to Ireland. We have invested 24b in the pillar banks and 30b via the wretched promissory note in IBRC. The proposal on the table will not give us any relief on these. The government in march 2012 engaged in a complex shell game to avoid payment of the note but this was for a one year basis. Despite this can kicking they continue to claim that they have avoided repayment, which is simply untrue. Thus a solution to the deferred 3.1b and the regular 3.1b needs to be found before march. All indications are that this will involve a restructuring of the repayment schedule, to reduce the amount of money destroyed from 3.1b to perhaps 1b per annum. That anyone outside a lunatic asylum would consider it acceptable for a state so broke that it is cutting respite care to carers to destroy a billion euro shows how degraded our political debate has become. After Minister Rabbit stated that we would not pay in March I asked the Central Bank, the ECB and the government for a statement. Despite being the ultimate loser in any refusal to pay the Bank declined to comment. The ECB reiterated the statement by its president that it was Frankfurts way all the way, while the government press office reiterated that we hadn’t paid in 2012 and were seeking a deal. None of these give any hope that a meaningful reduction in the outstanding debt, as opposed to some restructuring of the payment schedule, is in the offing. That wont prevent the government from touting some form of interest reduction or extension of the repayment schedule as a triumph. But it should.