At the beginning of October, Bank of England Governor Sir Mervyn King proclaimed that we faced “the most serious financial crisis we’ve seen, at least since the 1930s”. Two weeks later he ratcheted up the pressure saying “time is running out”. While his initial comments provoked outrage, his second speech seemed to hit home and those who have had their heads in the sand are starting to admit that he is correct: bankers and European governments must get their act together fast to avoid a default which would be catastrophic for banks and businesses.
Banks and financial markets are pivotal to the smooth running of the world economy. Through the structure of credit and debt instruments to the facilitation of capital flows and the provision of ‘utility’ banking functions, they underpin the entire business environment. The banks, however, now find themselves facing a number of diametrically opposed challenges. On the one hand they are expected to extend credit to help kick-start the economy, while on the other, they must deal with the continued financial fallout. This has manifested itself in a plethora of new regulations (such as Dodd Frank, Basel III, Solvency II and for UK banks the ICB recommendations) all of which will have the effect of reducing the amount of capital they can apply to their various businesses.
In addition, bank balance sheets continue to be deleveraged and de-risked. One consequence is a reduced appetite to lend and another, smaller returns for shareholders. The banks also face a new round of European stress tests. Whereas stress tests conducted in the summer exposed a €2bn capital shortfall, today’s consensus is that balance sheets need to be bolstered by between €100-275bn in order to deal with further potential economic shocks to the system (read sovereign debt default).
Take a bird’s-eye view
The banks have a lot on their plates and doubtless would argue that self-preservation comes first. This risks a corrosive impact on small and medium-sized businesses looking to the banks for investment funding. While larger multinationals may be insulated from this backdrop, SMEs face tightening credit availability on less attractive terms. But all is not lost. We are starting to see banks working with smaller companies to structure credit facilities at rates that are very attractive, with a number of banks viewing the exercise as a loss-leader to attract and retain clients with the option of selling in other services at a later date.
Businesses need to look at sourcing models to make sure they are getting the best deals and achieving the best prices, and perhaps outsource or relocate some operations to areas offering tax breaks or other incentives such as those available in the UK under the auspices of Regional Development Agencies and Enterprise Zones. Payroll should be examined – bonuses cut, eliminated, deferred and/or linked to higher productivity, salaries reduced, a moratorium on overtime or the introduction of part-time working, headcount reduced through waste reduction and efficiency gains. It may also be worth looking at divestments, although M&A activity is at a historic low partly due to lack of investor appetite and availability of leveraged finance.
A comprehensive front-to-back review of the business ‘Current State’ should be performed in order to gain a holistic view of functions, processes, people and technology. Prior to such moves, consultation and communication with those potentially affected is also imperative and must be managed at the most senior levels to ensure not only a Duty of Care but also buy-in from those affected. This approach substantially de-risks business transformation to an agreed Future State.
Weather the storm
Furthermore, the continued shift in global markets towards India and China cannot be ignored. As austerity bites in the West, China is moving away from an export-driven growth model to one focused on growing domestic demand, which offers good opportunities to European exporters. Similarly, India’s population is projected to overtake China’s in the next 20 years and its young, increasingly affluent demographic is hungry for Western brands.
For larger corporates, the issue is not necessarily access to funds but market confidence, and here we need governments to take the lead. In the UK, the Coalition needs to embark on large-scale capital expenditure programmes focused on infrastructure such as roads, high-speed rail, renewable energy and power stations. In the eurozone, there needs to be a firm lead from Germany and France and the three-pronged approach that has been proposed by many commentators: recapitalise the banks so they can weather any further shocks to the system; increase the haircut private investors have to take on Greek debt; and build a firewall around Greece to prevent contagion through leverage of the European Financial stability facility.
Such a plan is frought with complexity and certainly does not address the eurozone’s structural issues, but with Sir Mervyn’s words ringing in our ears, we are surely at the point where any half-convincing plan is better than none.