Published: March 21, 2000
In this month’s edition, we are privileged to be able to interview Dominic Broom, Head of Market Development, Treasury Services EMEA, The Bank of New York Mellon, who talks about pressures and challenges that are facing many mid-cap companies, and how their banks can help.
In this environment, many are concerned by availability of working capital and by liquidity management. Throughout the supply chain, suppliers are reducing the credit terms they are prepared to offer, to the extent that payment in advance is increasingly sought. This obviously squeezes companies’ working capital, particularly if they are also finding that their own customers are seeking to extend payment terms or are delaying payment, which is the experience of many firms. These opposing pressures can lead to potentially crippling cash flow difficulties, leaving companies at risk of being unable to meet their obligations. In addition, the risk of payment default from customers is increasing, further intensifying the liquidity challenge for theoretically solvent companies.
In the current market too, the overall situation is inevitably exacerbated by the substantial decrease in the availability of credit. This makes it harder for treasurers to find and put in place funding bridges to help them traverse liquidity gaps.
Despite efforts from central banks to pump liquidity into the banking system, many mid-caps remain cut off from funding. Indeed, some banks have cut credit lines previously provided to such clients. Banks are extremely concerned about extending credit that could increase their number of bad loans, and so are determined to err on the side of caution. While in some ways this is laudable, it does mean that potentially buoyant businesses are in danger of being refused credit and sinking as a result.
This flawed approach to the provision of credit needs to be replaced with a comprehensive, consultative system operated at a local bank level.
Changes in the models used by banks to determine those eligible for loans, coupled with changes in the economic climate, have combined to create a disconnect between those in charge of making lending decisions and the businesses that require credit.
At an individual level, regional banks have lost the skills required to perform in-depth evaluations of prospective borrowers. The ability to look at a company and undertake a full credit analysis, formerly a cornerstone of a local bank’s relationship with a local company, was superseded by head office models that favoured the provision of lending on a more commoditised basis. Indeed, before the crisis, it was not unheard of for firms to be offered loans which they didn’t need.
Now, however, the paradigm has changed. Banks still don’t know enough about companies, but have become unwilling to lend, despite experiencing political pressure to support SMEs and mid-cap companies in particular. [[[PAGE]]]
This flawed approach to the provision of credit needs to be replaced with a comprehensive, consultative system operated at a local bank level. Local banks must develop the skills to look closely at the individual circumstances of each company, including mid-cap firms, that comes to them.
Many local banks simply do not have the technology required to gain the necessary understanding of the workings of a client's business.
This includes an examination of the company’s working capital position and the detailed cash flow dynamics. Cash flow projections, asset values and supply chain information pertaining to the strength of the order book are all important for assessing the needs of the company. This information can be used to help determine whether there are inefficiencies that can be addressed to unlock value already present in the company. Prompted by its bank, a company may even realise that, a smaller credit facility than it anticipated, coupled with a cash management overhaul may resolve its liquidity difficulties.
In addition, the level of information a bank needs to provide advice about cash flow modelling and releasing trapped value means that it also gains a more informed position when considering lending. An analysis of a company’s supply chain management also has the potential to provide considerable insights into a company’s likely present and future health.
The ideal model for mid-cap company is one approaching a negative cash conversion cycle, whereby payment is received as quickly as possible after an order is placed. Once payment has been received, company’s suppliers can then be paid. Depending on the actual business of the company, this model may or may not be realistically achievable.
Nonetheless, the identification of more imaginative and creative approaches to cash management, facilitated by the use of technological tools to gather, share and process information, may be a service a bank can provide. Such a service is potentially as valuable in creating liquidity and easing cash flow dilemmas as an injection of funds.
Once upon a time banks did do this, but this function has now been centralised in bank head offices, so town centre bank managers have lost touch with the needs of local businesses. We are advocating a partial return to that local delivery of banking services. However, in an era of global trade and complex business arrangements, many local banks simply do not have the technology necessary to gain the required understanding of the workings of a client’s business. In addition, the costs of developing the necessary infrastructure to monitor, collate and report on a business’s every activity are prohibitive. Systems such as The Bank of New York Mellon’s Trade Workstation facilitate the electronic compilation of all trade and supply chain activities a user engages in, whether undertaken via open account or with recourse to risk management instruments such as Letters of Credit (LCs). Information is updated in real time, showing at any point the location of goods and funds, thereby reducing the operating and financial risks inherent in such activity. Such systems can also be integrated with back office functions, allowing treasurers to easily monitor and manage their working capital positions.
In a similar vein, cash management delivery systems such as The Bank of New York Mellon’s CA$H-Register Plus provide treasurers with online, real time access to their company’s accounts, and allow transaction initiation and monitoring. Intra-day reporting is accessible, helping ensure maximum visibility of information.
However, the cost for the head offices of local banks to develop such systems is, as has been noted, likely to be too great.
There is a reluctance to “get it wrong”. If a bank HQ outsources to a third party that, for whatever reason, turns out to be the wrong choice of provider, upfront fixed expense is incurred uselessly. Furthermore, if the system fails to provide the analysis required to help make accurate risk assessments, and therefore lending decisions, there is a risk of further costs ensuing as a result of companies defaulting on their debt.
There are specialist software and technology providers which have developed programmes to provide information management and collation functions. However, this is not an ideal solution, as they tend to be off-the-shelf products that come without a holistic service to ensure successful integration and use across the bank’s client base. As a result, banks are often reluctant to engage with such providers.
Of course, the global or multi-national banks that have developed the expensive systems to provide to their own clients do provide outsourcing services to regional banks. Yet there is a potential danger here of a bank providing its larger peer with insight into its local business, and thereby helping it establish a regional foothold from where it may well try to take business from the regional operator.
No – and they shouldn’t. Local banks add value through the customer relationships they hold with their clients. What is required is merely for local banks to identify the best way to provide value adding services to their clients. The solution is for regional banks to form outsourcing relationships with banks such as The Bank of New York Mellon, that can guarantee not to compete for their local business. The experience and transaction data shared in such partnerships, means that local banks can ensure they are better informed when it comes to making lending decisions. In addition, the complete picture of the company that they have gleaned may allow them to provide consultative services, identifying efficiencies that can be implemented and suggesting creative solutions that may reduce a company’s level of dependence on debt, potentially vital advice in today’s market.
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