Banks are not playing too safe when granting credits

(401(K) 2012, CC BY-SA)

ObserwatorFinansowy.pl: During the pandemic banks are apparently extremely restrictive. Consumers are not getting mortgages and companies are not getting investment loans. However, the Poland’s central bank, NBP September survey indicates that it’s hard to talk about a credit crunch in relation to the non-financial sector.

Piotr Boguszewski: Yes, but it should be added that the very definition of credit crunch, or what we describe in Polish as an excessive tightening of lending terms, causes many problems. The key word here is “excessive”. After all, we should not treat the desired caution of the banks as an anomaly, as well as the fact that during difficult times a number of sound investment projects is limited, while the majority is not rational from financing and implementation point of view. When we deal with a high risk and, even worse, uncertainty, we expect that financial institutions will be more cautious.

In such times, demand for credit is also probably falling, isn’t it?

Of course. We observe a decrease in banks’ lending activity, partly due to the lower demand for external financing, including credit, and not due to bank’s supply policy. To diagnose the risk of a credit crunch, we need to determine the strength of the impact of this factor. Currently this is difficult as two components are overlapping — the normal, cyclical slowdown of the economy and administrative decisions causing an extraordinary, temporary suspension of activities of certain sectors and restrictions on the movement of people, the transport of certain goods, etc. The empty hotel rooms, empty cinema halls, and empty tables in restaurants are the best illustration. Therefore, the sharp fall in economic activity reduced demand for working capital loans. Since liquidity problems also appeared in some of these companies — also because of the necessity to incur fixed costs in the absence of revenues — these firms had to search intensely for sources compensating their deficits. According to the NBP surveys, many companies had to suspended or even completely abandoned investment projects. This of course has translated into a decrease in potential demand for investment loans.

Are there lists of sectors that will not get a loan? For example, if I have a profitable hotel and I need only a small loan, will the bank give me credit?

This is an important question and a lot of misunderstanding. Above all, credit refusals are not one of the signs of a credit crunch. In economy there are always so-called declining areas of products or technologies which social importance is diminishing in the long term. For example coal mining, or some of the energy technologies that rely on this commodity. So, there is a very little chance that an enterprise from such sector will have a profitable investment project, not to mention an acceptable level of risk. Therefore, by avoiding getting involved in financing uncertain activities, banks are behaving rationally, and in this case there can be no talk of any “excessive tightening” or credit crunch.

However, it’s not good when banks apply this rule automatically in relation to a sector which is experiencing temporary difficulties. But we have to remember that banks are required to act rationally. Let’s say that a company from the hospitality sector has a sensible business plan, and applies for a relatively small loan, like EUR30,000. Since this is a high-risk industry, verification of such a loan application is very complicated, long and expensive. In the case of a small amount, it might simply be unprofitable for the bank.

Of course, the bank would “break even” by applying a higher margin. However, there’s a trap because it’s not clear whether the investment project in such a risky industry would still be profitable for the company if the external financing costs are higher. So if the project is not profitable we shouldn’t talk about the credit crunch. The loan agreement was not concluded, not because the bank was “excessively” cautious in granting loans, but because the company did not have an investment project profitable for both the company and the bank.

So nothing bad is happening, even if the black lists of sectors really exist?

The number of refusals for enterprises from a specific industry, treated as an indicator of a credit crunch, in fact is closer to abovementioned automatism of credit decisions. That would be the case in normal times. However, let’s remember that we are dealing with a so-called administrative shock. The regulations affect all or almost all enterprises in certain sectors. During a “normal” crisis there are restaurants in a better and worse economic condition, during the lockdown all of them are closed. This would therefore justify the unification of banks’ decisions in such cases.

The report states that “In the SON0720 survey [a survey done between the end of July and beginning of August 2020 on a sample of approx. 700 companies — ed.], trading companies and industrial enterprises prevail, as well as smaller firms from the SME sector. These enterprises have indicated difficulties in negotiating with banks and experienced a deterioration in loan availability despite the majority of them being creditworthy.” So who exactly faces a credit crunch?

We have analyzed over 700 companies and such situations were very rare, only few per cent of the respondents. In particular, the phenomenon which is actually the essence of the credit crunch — the so-called refusal to finance a good investment project because of the excessive caution of banks — was marginal.

Would firms that were refused a loan after the outbreak of the pandemic have also been refused a loan earlier?

It’s a very important problem and we should treat this few per cent with caution. While surveys are, in my opinion, probably the best method to research the potential phenomenon of credit crunch, they are not a perfect one. Both parties to a credit agreement may have a tendency to formulate biased responses — they will try to objectify their actions. In particular, enterprises that didn’t get loans might tend to place the “blame” only on the bank. When interpreting the results, we must take into account psychological determinants. However, in our sample this was a marginal issue, because a large number of companies that were refused a loan had openly mentioned their limited creditworthiness in the pre-pandemic period.

“However, due to the strength and nature of the pandemic-related shock, credit risk increased significantly in all credit categories, and the risk of a credit crunch emerged,” states the press release after the meeting of the Financial Stability Committee (FSC) in June 2020. Therefore, the warnings of a credit crunch were appropriate in June, but in September a credit crunch practically does not exist?

There is no contradiction, if we interpret both diagnoses more precisely. From analyses based on SON07 and later data, it turns out that up to September a credit crunch, at least on a large scale, did not occur in Poland. Despite a marked deterioration due to the COVID-19 crisis, the financial position of non-financial companies remains quite good, given the scale of the shock. But we know it now. In June we didn’t.

This is due to a large flexibility of Polish enterprises — also due to historical experiences — and the good results of the sector before the pandemic. Also, the implementation of state aid programs, including the measures of the central bank, NBP, helped. It should be stressed that the diagnosis of the FSC indicates the necessity to closely monitor the situation also in a longer perspective than September, and not only in the non-financial sector. This is particularly important in the conditions of persistently high economic risk, including uncertainty about the further course of the pandemic.

Or maybe there is still a risk of a credit crunch? Over 60 per cent of all bank debts are consumer, not corporate ones. When the state aid ends, the situation on the labor market, as well as consumer loan repayment, might deteriorate, which would affect the banks’ balance sheets and their possibility to lend to companies. Can we imagine such a scenario?

We not only can imagine it, but we have to imagine it so that it will not happen. This is why it is so important to monitor the situation of non-financial enterprises, because stability in this sector means the lack of deeper shocks on the labor market, and thus less disturbance in the financial situation of the households..

According to the report “In the Q2’20, factors beyond the control of companies were the most common reason for issuing negative credit decisions, which can be explained by the high uncertainty.” Has this uncertainty disappeared?

Two factors will probably have a major influence in the near future — the further development of the pandemic, and the effects of the state aid for domestic companies. All depends on how quickly, after the suspension of the state aid, companies would be able to do business independently in the current situation. And here I am rather optimistic, as are our respondents.

Can you explain the paradox of the liquidity? According to the report, quick and cash liquidity ratios are rising rapidly, but the percentage of companies declaring no liquidity problems is declining.

The simplest explanation is the common sense of enterprises. Companies realize that they have received a large injection of cash, but it was an emergency aid, and not the recurring operational profit. This is a fundamental difference. Companies know how fixed costs work and how dangerous they are when there is a risk of insufficient demand. And future income are still uncertain. Alongside other effects, uncertainty increases the need for liquid funds. Hence the apparent paradox — I have more money, but I don’t feel confident because I also need a larger financial cushion.

How important is studying a potential credit crunch, when Polish SMEs finance themselves?

Although the credit crunch is a popular topic, one aspect of its economic importance is probably too rarely mentioned. An excessive restriction of credit supply can have measurable economic effects if it stays for a longer time and/or affects the financing of large or several small investments. Meanwhile, there are a lot of companies in the SME sector. Yes, traditionally in Polish enterprises’ own funds play the dominant role in financing investment.

There are many reasons for that. They include the shorter credit history, smaller assets which could be used as collateral, the lack of qualified staff preparing the credit documentation, etc. We have to remember that many of Poland’s medium companies are small compared to enterprises from the developed countries. So they have more difficult access to bank financing. To a certain extent, this financing structure makes our economy somewhat more resilient to a credit crunch. However, this does not mean that it can be ignored, because the dynamic development of a series of enterprises, also in the SME sector, depends on the possibility to obtain external funds, particularly in the case of the implementation of larger investment projects.

Piotr Boguszewski, PhD, is an advisor in the Economic Analysis Department of Poland’s central bank, NBP.

The views expressed in this article are the private views of the author and are not an expression of the official position of the NBP.

(401(K) 2012, CC BY-SA)

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