For any bank evaluating a loan application, the first consideration is whether the business in question can afford to repay the amount being sought. This is sometimes called serviceability. Without evidence that sufficient cash should be available to meet the resultant debt and interest, the verdict will always be ‘no’. Most business owners would probably agree that this approach is perfectly fair and reasonable.
Hot on the heels of serviceability comes another factor: security. This is about the collateral which a company can provide as a safeguard. And to be honest, if you ask a business to describe their discussions with banks about security, their first words are pretty unlikely to include ‘fair’ or ‘reasonable’. So what’s the problem?
Security is partly a question of identifying secondary exit routes – lender-speak for assets that can be sold off if needed to repay debt. Banks have become accustomed to using tangible assets that have resale potential, like commercial property, for this purpose.
At first glance, this policy seems perfectly sensible. The ability to realise value in extremis seems particularly important in a period of economic uncertainty and low growth.
However, to rely on tangible asset security solely for this purpose would be to have an extremely short memory. Over-exposure to tangible assets that people thought were valuable is not only one of the practices that got half the world into its current mess, but also continues to be one of the reasons we can’t get out of it.
No, the real reason for taking security is because lenders know the importance of their customer having ‘skin in the game’ – showing their intention to repay by putting something of value at stake.
Banks want, and need, the businesses in question to make a real commitment of their own; but as is widely reported, security is the place where many conversations between banker and business currently fall down. In the absence of available, tangible, company-owned assets, directors generally get asked to put up their personal assets to fill the gap.
This seems to be borne out by ONS data (see blogs passim). Not only is the lack of collateral the biggest single reason for declinations being given; but also, where loans are provided and guarantees are obtained, they come from owners and directors in 94% of cases.
The data also points to one (although only one) of the reasons why the Enterprise Finance Guarantee scheme falls short of the mark. EFG is great in theory as it recognises that many companies don’t have enough of the kind of security a bank traditionally likes to see. However, the scheme can’t be used unless all other avenues – including personal assets – have been exhausted, which is why it hardly features in ONS data.
What’s needed to create good quality security is an asset class that is truly core to the business and as closely associated as possible with the way it generates value, rather than a commodity that the company can do without or easily replace.
Anything come to mind…?
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