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SME credit risk management

Finance: from cradle to grave

Banks are good; honestly!

Bank scandal: here we go again



Bank scandal: here we go again  Feb 2013

Never one to learn from their misdemeanours, banks are again embroiled in scandal.  The latest involves a curiously-named financial product called a swap (aka: derivative and, unfairly, ‘weapon of mass destruction’). This type seems to have been especially destructive – blowing up both the SMEs that bought them and the banks that sold them.

At their very basic, a swap enables the buyer (a SME) to convert (swap) its interest rate from fixed to floating rate, or vice versa depending on the SME’s expectations for future interest rates. 

If the SME is paying a variable interest rate on its loan but is concerned that interest rates will rise (so reducing its profits), it could buy a fixed/floating swap from a bank to swap its variable interest rate (e.g., LIBOR) for a fixed interest rate, e.g., 5%.  

If the SME’s prediction is right and interest rates do rise (e.g., to 8% LIBOR), then it will receive 8% from the swap bank and pay 5% to the bank, a saving of 3%.  

If the SME bets wrong and interest rates fall (e.g., to 1% LIBOR), then it will pay 5% to the swap bank but receive only 1%, a net loss of 4% – especially galling when its less financially savvy (or should I say, less hubristic) competitors did not buy a swap so simply continue to pay the variable rate on their bank loan.

If a SME’s revenue falls as market interest rates fall, it could soon be insolvent because it can no longer pay the cripplingly high interest payments on its swap. 

Some SMEs in financial distress are claiming banks missold these swaps to them.  When they’ve tried to get out of the swap the banks have slapped them with massive early termination fees. 

Who’s to blame for this latest mess: banks or SMEs?  The reality is probably both. The FSA has found regulatory failings in over 90% of a sample of cases of derivative sales by banks it reviewed.  Banks have recognised their expected liability, by setting aside hundreds of millions of pounds for likely redress, and they could pay many times more (think PPI £billions). 

Before signing up to a swap, a responsible and considerate business director should have asked:  what if my forecast of interest rates is wrong and interest rates actually fall; could I pay the extra interest?  Can I get out of this swap early, and how much will it cost?  Is the bank telling me the whole story and being honest with me?  What are the risk factors?  Do I really understand how this transaction works? What if I don’t comply with its terms?  Have I taken independent advice?  

Used properly, swaps can be very effective for managing interest rate, currency, and credit risks in companies and banks.  This latest scandal yet again illustrates that it’s the misuse of financial products (caused by peoples’ greed and hubris) not the products themselves, that leads to financial ruin.

Dr Singh is a Chiswick-based corporate treasury consultant, visiting university lecturer, and proprietor of Applied Corporate Finance


single invoice finance


Banks are good; honestly!  Jan 2013

Have you ever thought how society would cope without banks?  A lot better off you shout!    

Most people and businesses want instant access to their money, and because they don’t have the technical ability to assess a company’s credit status, they would be reluctant to lend to businesses.  Even if they did lend, it would be for no longer than a very short period. 

If a business doggedly tried to raise money itself, it would be very expensive and time consuming finding and then dealing with many small investors spread, potentially, across the UK, Europe, or farther afield.  Imagine the time, language and cultural impediments, and the problem to coordinate all these disparate and small lenders into a loan agreement.  If, miraculously, lenders were prepared to lend to the borrowing company, without banks, how could the company convert potentially thousands of small foreign currency loans into its domestic currency?  Many currency converters that have sprung up over the last 5 years are actually dependent on banks for providing them with currencies.    

Imagine the borrowing company’s difficulty to track down, negotiate and get approval from a minimum of 51% of the disparate lending group to effect a change to the loan agreement.  Compare how more easily a company could effect the same change from a loan from one bank on the high street.

Without a network of banks to facilitate funds transfers, paying periodic principal and interest to so many disparate lenders in their own currency would be next to impossible and prohibitively expensive for a borrowing company.

Banks, for all their faults, (and there are a lot of them, and growing daily it seems), are good for society. 

Banks provide effective intermediation between lenders and borrowers: taking small instant access deposits from thousands of individuals and handing the money back out to borrowers as loans for up to 25 years (maturity transformation). Other benefits banks provide include: funds transfer networks globally; currency conversion; risk management (taking currency, credit, interest rate and liquidity risks off borrowers and lenders and assuming it themselves).

Banks capture economies of scale and so costs of transactions are smaller for companies than if companies dealt with many counterparties directly. 

With banks, borrowers don’t need to wait, potentially decades, for a lender to come along with coincident wants before the borrower could trade, so a society with banks trades more often so it grows and prospers more than a barter economy. 

Bank intermediation avoids the free-rider problem, where individual investors delay transacting because no one wants to make the first move and incur necessary costs of research and analysis, that other investors then benefit from.

Banks offer access to far more financial products and financial markets (the value-enhancing ones that is) than individuals and companies could get access to on their own.

Dr Singh is Proprietor of Applied Corporate Finance, a Chiswick-based corporate financial services business

He designs and delivers courses on finance, including: financial literacy, an Introduction to the City, and international finance.


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Finance: from cradle to grave  Nov 2012

The subject of finance elicits many and varied responses in listeners: yawning; despair; anger; confusion; concern; evasion.  There’s no getting away from it, finance rules our lives to an unhealthily large extent. It has this hold on us from cradle to grave.

Daily, individuals are forced to deal with a plethora of financial transactions involving either paying or receiving money, covering almost every conceivable human activity: utilities, rent, mortgages, bank accounts, loans, transport, telephone, education, holidays, entertainment, taxes, insurance, pensions, shares, savings accounts, shares, and investment portfolios.   

Often we are left confused about how these figures have been calculated by the other party.  Companies make their bills and statements evermore opaque and confusing.  Have you understood how they arrive at the figures on your mortgage statement, your energy bills, your telephone bill, even your salary slip’s tax, NIC and pension figures?   If you don’t know what these transactions mean or how they’re calculated, can you be sure the figures are right or fair?  Perhaps the companies want it that way so they can fleece uninformed consumers with unfairly high charges. 

Have you noticed how mortgage arrangement fees have risen so much?  Could the high level be to offset the low interest rates banks lend at? But banks are paying very low interest rates themselves, so aren’t they getting a double-boost to their bottom-line (their profits), and each time at the consumer’s expense?

Why don’t energy companies lower their consumer energy prices?  Could it be they want to fatten their profits and hope the consumer does not notice that their wholesale prices have fallen?

If you decide to set up your own business, there are again all sorts of financial transactions to process.  If you work for an employer, you might still be confused about how your company makes its money, or how it managed to make a loss after record sales. 

Beyond our personal sphere, we are bombarded daily with news about the state of the economy, a double-dip recession; government debt and spending; GDP, fiscal policy; monetary policy; quantitative easing; inflation; the trade deficit, the appreciation of the pound and capital inflows, and so on and so on. 

The last 15 years has witnessed an unprecedented change in the global financial landscape, especially in the UK – which has been the dominant financial centre for decades: innovation and wizardry, sophistication, deregulation, and the availability of easy money at the personal, corporate, and government levels.  The binge on easy money and reckless behaviour has culminated in a massive economic headache at the personal, corporate, government, and international level. 

The chief economist of the IMF reckons a decade of economic growth and development will have been squandered before growth is resumed – meaning six more years of financial hardship to endure for millions of individuals and companies in this country and abroad.

Dr Singh is Proprietor of Applied Corporate Finance, a Chiswick-based corporate financial services business

He designs and delivers courses on finance, including: financial literacy, an Introduction to the City, and international finance.


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SME credit risk management   Sep 2012

Credit scores provide an assessment of a business’s financial health, with a low score implying that a business is more likely to fail.  

A survey of 700 UK small businesses by credit reference agency, Experian, found that 71 per cent did not check their customers’ credit status, exposing them to a greater risk of being paid late or not being paid at all.

The survey also revealed that 39 per cent of small businesses did not know what a credit score was. 

Graydon based in Middlesex, provides access to business information on over 100 million entities in more than 190 countries.  Companies like Graydon track tens of thousands of UK and overseas companies’ trading activities, and financial and credit performance, and over time build up a detailed picture of each company’s credit history and status.  Some add further value by analysing the information and providing recommendations and credit ratings of companies. 


Graydon for example, provides a dashboard of key statistics about a company: overall credit rating, credit limit, likelihood of financial distress in the next 12 months, and payment score (the likelihood the company will pay its invoices on time).


This information is sold as credit reports to companies who might be thinking of trading with a company and extending credit to them, or who are perhaps thinking of extending further credit, or they’re concerned about the possibility of default. 


“In the current economic climate it is now more important than ever to understand and manage both risk and opportunities that exist in the market” says Craig Evans, Head of Business Development at Graydon UK.


Companies House provides a free online service that provides basic details of a company and this can be a useful initial source of financial information.  For just £1 each, regulatory filings, such as annual accounts and annual returns, may be downloaded.  Information about security given, such as mortgages, can also be obtained. 


Whilst useful, be careful about relying on information from reports because it might be out of date.  Companies for example have nine months to file their annual accounts.


It might be easier to just pass on the credit risk of an invoice not being paid by purchasing single debtor protection.  Cover is also available over selected invoices, or over the whole sales ledger.  When taking out cover, do check whether the policy will pay out where a debtor defaults because of a dispute over the invoice (protracted default) or if it will only pay out if the debtor defaults because they are insolvent.


Outsourcing invoice collection can save companies substantial time and costs, especially where the debtor defaults so collection becomes protracted and involves litigation and court filings. 


“Late paying customers can have a disastrous impact on a SME’s cashflow and profits.  At Pulse Credit Solutions, outsourced credit collection is available for less than the minimum wage”, says Kevin Downton at Pulse Credit Solutions.   


Dr Singh is Proprietor of Applied Corporate Finance, a Chiswick-based corporate financial services business.                                Back to top