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FD Report: Governance, risk and the future of banking

As a worrying outcome of the continued pressure on loan finance, some organisations may be tempted to put their banking needs out to tender – to hunt assiduously for the best and cheapest deals around. In doing so, they consign previously long-standing relationships with their banks to yesterday’s way of doing business.

It is a picture that looks feasible enough as the fallout from the recession rumbles on and as accusatory headlines accumulate – pointing the finger of blame firmly in the direction of the banking sector.

In fact, some commentators suggest that while some companies may well adopt this approach, more enlightened organisations are likely – and would be better advised – to undertake a full strategic evaluation of their whole funding picture if they haven’t already: debt, asset finance and capital. This approach, they say, should not be a means of ruling out bank lending or displacing banking relationships, but of complementing them with other forms of finance and providing banks with an assurance of risk sharing.

Ash Mehta, chief executive at interim FD supplier Orchard Growth Partners, says that the forced re-evaluation of banking relationships that has taken place over the last 18 months is having positive effects on business behaviour. Where once, FDs may have been surprised when relationship managers came back with more and more requests for information, now they anticipate those requests.

“People factor this in now,” says Mehta. “Companies are more prepared in terms of what will get them through the credit committee. And in any case, asking for more information has got to be a good thing for the longer term.”

Greater analysis
Businesses, he says, are now in the habit of asking questions of themselves; modelling different scenarios and probing the assumptions behind the business plan. For some it has become second nature.

“Businesses are taking the whole of the banking relationship more seriously,” says Mehta. “The impact that the banks are having is causing companies to have better governance. It may have been inadvertent but it is quite healthy.”

Gary Davison, capital and debt advisory partner at Ernst & Young, says what is important is an appreciation of where we are in the economic cycle and where the banks stand. Typically, banks track slightly behind other sectors during a recovery. “The credit crunch has come and gone,” he says. “Banks now have reasonably robust balance sheets, but they’re still faced with challenges.”

Bad debt rising
Davison expects the banking sector to grapple with the emergence of more bad debts within their corporate portfolios throughout the rest of this year and into 2011. Legacy debts will only be part of the picture, however. Good businesses that have clambered their way out of recession will emerge with lower valuations. Businesses once worth £100m may only be valued at £70m and the shortfall will have to be addressed – with straight write-offs, with swaps or the selling down of debt. Private equity will undoubtedly play a role, he argues.

So there is still likely to be pain ahead in the short-term before we begin to sense the feel good factor returning to the banking sector. “We still have to get through this period, but for the present and through 2011 we should see a sense of stability being restored to the market.”

While banks remain undeniably cautious, they are, argues Davison, still looking to support businesses. For those businesses that don’t have a great deal wrong, or issues with important customers – and have good relationships in place – banks will want to play their part, he says.

“They are very much more neutral in how they present to credit committees and still show a cautious approach,” Davidson thinks. “They are not pulling rugs out from under businesses but they are not putting their heads above the parapet either.”

The part banks wish to play is one of risk sharing – on the basis of full disclosure and understanding of the client business. The onus is firmly on FDs now to provide strong management information and to take ownership of any issues within their markets.

For corporates with a good approach to governance and a well-articulated business plan, there is certainly light at the end of the tunnel in terms of the willingness of their bankers to continue to lend. But they need to be transparent, show they understand their market and be ready to demonstrate proven potential. Banks won’t lend on the back of the ‘hope factor’, Davison says.

Still competitive
In terms of the UK business environment and the way in which the UK has emerged from the credit crunch, it is clear that our relationship with debt has to change, Davison believes. Too much debt, priced too cheaply, has to become a thing of the past. “Banks have to charge a correct margin for their business. Previously they have relied far too much on profit from investment business products. The debt price today is still relatively competitive.”

Mehta argues that rather than shopping around for more competitive rates, he is seeing companies staying with existing bank relationships or tapping into their shareholder base. Today’s conditions call for an approach that is both open-minded and pragmatic in terms of how businesses acquire cash, he argues.

“It is not about taking the path of least resistance,” he says.

Davison advocates a strategy for overall capital and less reliance on borrowed money. “There is nothing wrong with debt but the question should not be ‘how much can I get?’ but rather, ‘how much do I need?’. What is the optimum amount for what I am trying to achieve?’ That way we will get away from situations that are over-leveraged.”

Overall view
An approach that looks at whether finance can be raised in relation to assets, at whether costs can be cut, working capital preserved or alternative finance raised will demonstrate a broader and more strategic outlook. In the process, people are refocusing on debtors, stock and other options to free up cash that may be tied up within the business, Mehta points out. It is also an approach likely to win friends and influence bankers, demonstrating a willingness to communicate and to share risk.

But the FD cannot operate alone. This kind of strategy needs to be evidenced throughout the executive and management team. “You need to have this thought process with your board and with stakeholders. You need a good governance structure around your thought processes on the back of strong management information so that what you are trying to achieve is absolutely clear,” says Davison.

Up until now, many corporates will admit that their focus hasn’t always been on these issues. But many quality mid-market corporates will now be looking at just these questions. Those that do are more likely to emerge into the recovery fit for purpose. “If you get your strategy right around your long-term capital you will gain an edge, as not everyone will have done this,” says Davison.

“And as we know, out of recession comes massive opportunities.”

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