Banks' reluctance to lend could spell failure for many smaller suppliers

 

By Graeme Davies

18 December 2008

Despite the Bank of England's recent reduction of headline interest rates by another 1 per cent to a historically low 2 per cent and expectations that this could fall even further in the early months of 2009, banks remain very reluctant to lend to each other and hence to their business customers. This reluctance, at the very top of the lending tree, is creating increasing tension lower down in the business world, putting particular strain on smaller companies which struggle to adapt to lengthening payment terms from their larger customers.

Official figures show that the premium banks charge to lend to their rivals is the highest for several years and this feeds into a continued reluctance to lend to corporate clients. So huge government funding pumped into the banking system has not greased the wheels of the lending system yet, and if banks remain highly reluctant to even lend to each other, then they are even less likely to be keen to lend to corporate clients. This lack of credit is freezing the whole business system and the pressure is showing most sharply at the lower end of the market as larger companies are squeezing their smaller suppliers by stretching payment terms. Business insolvencies are soaring, with failures expected to rise by 50 per cent next year and then peak in 2010.

The increasing desperation of smaller companies is illustrated by the growing number of firms resorting to legal action to try to extract payment from their customers. FM firms are no strangers to this phenomenon with research by the Credit Management Research Centre at Leeds University showing a big increase in the number of business services companies resorting to legal action to get payment.

This is an extremely worrying portent for all sectors of the UK economy, apart from, possibly, the business recovery and insolvency industry, and the FM sector is likely to see its fair share of business failures too. For a sector with a significant exposure to struggling property and financial operators, the risks are all too clear, and companies with weak balance sheets showing significant debt are going to find themselves under the most pressure as they struggle to service their own debt due to growing cash-flow pressures.

For the whole FM sector, the potential fall-out could be worrying. As more companies fail, the sector will shrink and the necessary competition required to keep prices reasonable and the services satisfactory, in the process maintaining value for money for the clients, could disappear. The sector risks seeing the diversification at its lower end diluted as businesses either go bust or are swallowed up by larger operators or better-funded peers. There will be some clear winners in the long run, and some of the better-run smaller FM operators will emerge to become the sector leaders in future years.

Throughout the first half of 2009, at least, there is likely to be a good deal of pain endured at all levels, but most acutely at the smaller end of the scale.

Graeme Davies writes for Investors Chronicle