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Mind the credit gap

IT’S NOT EASY to gauge economic health when there are new headlines about sovereign debt and bailout programmes almost every day. Together with the European Financial Management Association we recently carried out an extensive survey of decision makers at top European banks to get some sense of economic indicators over the next six months.

Credit gap

While the results were not entirely surprising they did shed some light on potential recovery within the UK.  Many finance directors have realised that banks need a lot more convincing to lend following the financial crisis. However, optimism about credit performance in Europe is growing as credit supply and demand becomes more balanced.

This suggests both an increase in credit supply, spurred by stimulus programmes, and increased lender optimism. That said there is also a more cautious consumer attitude towards borrowing money. Also in small business lending, supply and demand for credit is more balanced thanks in large part to government stimulus programmes.

Despite this, FDs in the UK are likely to continue facing difficulties in accessing funding. The so-called “credit gap” for small businesses still persists, yet the forecast is much smaller than before. In the UK, 57% of respondents expect an increase in small business credit requested, while just 36% see an increase in the amount extended by lenders. This means that demand is likely to outpace supply for some time.

In the still-fragile UK economy, funding gaps combined with cautious consumers are therefore likely to stall economic recovery and stronger business growth. The recently announced UK GDP growth of just 0.5% in first quarter of 2011 confirms the extremely modest expectations banks have for economic growth. As a result, lenders remain cautious.

With government demands to increase loans to fuel the economy on the one hand, and increased regulatory pressure to reduce risky lending practices and a new downturn on the other, lenders are still mindful of the risks that face small businesses as challenging economic conditions linger.

This may not sound like good news for business, but the bright side is that both credit requested and credit extended are expected to be higher in the coming months than earlier this year. This suggests that government stimuli and bank programmes aimed at rejuvenating this segment of the economy will pay off, albeit more slowly than some would like.

Troubling housing market

Another economic indicator – the housing market – remains troubling in the UK and across Europe. When we look at the survey’s results, we can see it is too early to call the bottom on mortgage performance.

The outlook for mortgage delinquencies remains bleak and none of the survey respondents expect this to change in the coming months. Previously increasing property prices fuelled borrowing and increased business assets which in turn supported expansion.

However, the fall in property prices continues to expose consumers and businesses alike. And as we know high levels of debt and increased general caution leads to reduced consumption. However, on a more optimistic note, the picture for delinquencies in general is more upbeat than previously thought, although overdrafts on current accounts (which are a crucial part of the UK payment process) remain worryingly high. This feeds into the wider sense of caution both from the side of the banks and consumers.

Savings first!

While some of the results vary from region to region, the respondents spoke with one voice about the fact that the relationship between banks and customers has changed and the general attitude towards credit has also shifted.

“In the still-fragile UK economy, funding gaps combined with cautious consumers are therefore likely to stall economic recovery and stronger business growth.”

Today consumers are more demanding about the quality of the service provided by their bank and far more cautious when it comes to credit. Some of this shift reflects a change in economic circumstances that may be short-term.

However, the credit crisis and recession, and the role banks are perceived to have played in this, have caused long-lasting change in borrower attitudes. For example, over three quarters of UK respondents cited a greater mistrust of banks, which was far higher than the average 52% across Europe. This is not too suprising following a recession. But there are indicators that consumers are now less likely to spend. In the UK 84% of respondents said customers were more interested in building their savings, while 85% believe customers are more reluctant to secure or use credit.

Surprisingly these figures were higher than in the rest of Europe (79% said customers were more interested in saving, while two thirds said customers are more reluctant to borrow).

In the past UK consumers have placed less emphasis on savings but today’s reluctance to spend is likely to have the biggest impact on UK businesses. The proportion of income that is spent or saved is an important economic decision which has implications for the wider economy and is very much tied up with consumer demand. While a focus on savings is likely to create stability, it is unlikely to boost growth – particularly in the UK where the economy heavily relies on strong domestic demand for UK goods and services.

While these results are not completely unsurprising, they do prove that the UK economy fails to inspire confidence. A dim outlook for the housing market and consumers, who are more interested in saving than spending, will have a strong impact on sales and growth. A remaining funding gap for businesses will add additional weight to the situation.

But, it’s not all bad news for business leaders and financial directors; the signs are beginning to indicate improvements and growing optimism though these improvements may not manifest as quickly as some would like. But that said, these indicators do offer light at the end of the tunnel.

Mike Gordon is vice president and managing director of FICO

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