Kevin O'Higgins Solicitors

Have the banks forgotten how to lend?

Tuesday, 14 January, 2014
The Irish Times
Chris Johns

Central Bank governor Patrick Honohan gave a thoughtful speech to a conference last week, jointly organised by the European Commission and Trinity College, which looked at “Future Directions for the Irish Economy”. The Governor focussed his remarks on the banking system: his review of the demise of the Irish banks was familiar but nevertheless fascinating. His hints about the difficulties associated with negotiating the bailout are worth a read.

His suggestion that the conditions imposed by the Troika “disappointed the Irish negotiators” is probably hugely understated. As is often the case with such events, unscripted remarks can also be illuminating. Here, the Governor did not disappoint. In particular, his references to the still blocked SME credit channel are worthy of further analysis.

Access to credit for SMEs is a pan European problem. It is not just a Euro area issue: the UK has also grappled freeing up loans to small and medium sized businesses (with more evidence of success than in most other countries). The authorities here have tried to seize the initiative. For example, the establishment of the Credit Review Office in 2009 was an early attempt to solve this rather intractable problem. That it is still a problem is evidenced by Mr Honohan’s (unscripted) comments about the difficulties still being faced by non-financial Irish corporations in their dealings with the banks.

Here, Professor Honohan entered some unfamiliar territory. He speculated that one reason why credit is not flowing as it should is because of a “technological problem”. His suggestion is that banks may have forgotten how to do old fashioned lending; banks available “technological capacity” to do SME lending may have become obsolete.

There are a number of possible reasons why this may be the case. In the first instance, a lot of the SME lending that took place during the bubble years was, in fact, property related. Lending based on business models and analysis of cash flows of an underlying (non-property) franchise were shoved to one side as everybody - many different types of businesses - got in on the property game.

There are plenty of stories doing the rounds that suggest that the banks are having trouble getting to grip with their existing (poor or bad) loans to corporates precisely because it is just another dimension of the property bust. To the extent that any or all of this is true, it means that banks haven’t done much “proper” business lending for quite some time. In addition, given the downsizing that has been going on that the banks, people who can remember how to do such lending may well have left or otherwise moved on. This, I think, is what the Professor Honohan means when he talks about the technology of SME lending becoming obsolete.

Of course, it is hard to know just how big a problem this is. But it must be significant if Professor Honohan is moved to mention it in a reasonably prominent way. And it does have more than an air of plausibility. The skill-set necessary to do “old fashioned” corporate lending has always involved the ability to analyse a balance sheet, to gauge the plausibility of a profit projection and to make a considered opinion of a business plan. It’s a very demanding set of skills, with tools and techniques that have been growing in sophistication in recent years.

The modern job description for a business lender is not unlike that of an equity analyst operating in funds or investment banking. In fact, it’s probably more specialised than that. Given the nature of SMEs, lending to that sector probably requires skills similar to those of a venture capitalist. Knowledge of the world of private equity and other specialised forms of finance are also likely to be helpful. If these very modern specialist skills need to be combined with those of the forensic accountant, it is no wonder that Professor Honohan is wondering whether or not they are to be found in the banks.

So, reluctance to lend may not just be a function of risk aversion or the need for banks to shrink their own balance sheets. They may simply have forgotten how to do it.