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  • Alternatives to Bank Funding

    Maybe it was too easy to get financing in the past and now we have to become more realistic.


    Because of our history of years of economic growth, many organisations were levelling their balance sheets via bank debt. Because of the competitive banking landscape, banks were extremely willing to finance businesses. This created a surety of funding for many organisations. This climate has changed.

    The dominance of bank funding in Europe is in todays’ markets a negative factor. The financial crisis has shown the vulnerability of the European funding model. Robust capital structure of lenders (clients) are crucial to give more favourable funding terms, as higher capital indicates a lower probability of default. Furthermore the financial crisis has shown that banks are quite vulnerable to liquidity and funding risks.

    In particular the funding metrics in Europe differs unfavourably with the US. For instance the Loan to Deposit Ratio (LDR) in Europe was in 2014 around 120 %. This means that loans provided by European banks exceeded their own funding. In the US the LDR was around 50% in 2012. The latter results in a huge negative funding gap in Europe, and we see in the US an opposite situation.

    It is quite clear that a low /robust LDR below 100% indicates customer loans provided by banks are funded by customer deposits, while a LDR above 100% requires wholesale funding to complement insufficient deposits. Since 2009 we see that in most countries the LDR ratio dropped, but in Europe it is still above 100%.

    Above will result that the bank funding models for European banks are changing, it is clear that the European banks will face 1) a higher cost of funding and 2) a different structure of liabilities (altering the composition of funding).

    As a result of the decreasing risk appetite within banks, increasing capital requirements by external regulators and an increase of funding costs, banks are required to have higher quality and level of capital which leads to less and less willingness to finance your debt.

    Before the financial crisis, few corporations managed their own credit rating. Managing the balance sheet was considered less important than managing the profit and loss account. A positive lesson from the crisis is that this has now ended. Neglecting to manage your own credit rating and your own balance sheet will bring you the risk of not being able anymore to execute your business strategy because you cannot mobilise the required necessary funds. Organisations have to manage their balance sheet and their credit rating if they want to secure themselves for funding. For the longer term this is a key objective, and it is also the most important element to solve your funding problem for the longer term.

    Corporates will have to look into diversifying financing sources, especially in non-banking sources. This requires a different approach than in the past, and therefore this is an important strategic theme that should be high on the agenda.

    There is already a wide range of alternative financing sources available. This is expected to grow further.


    Private Placements Supplier Finance Crowd Funding
    Commercial Paper Leasing Hybrids
    Dutch MKB Bonds Factoring Cumprefs
    High Yield Bonds Securitisation “Informal” Investors
    Convertibles German Mittelstand Bonds Mezzanine
    Medium Term Notes Retail Bonds Unitranche
    German Schuldscheine Perpetual Bonds PIK Notes


    This required change in financing approach by corporates will also have an impact on their bank relationship policies and their risk policies. Organisations have traditionally been relying on their historical banking relationships.

    Funding costs will increase because it has become common to charge liquidity spreads, reflecting the cost of funding, and credit spreads, reflecting the risk premium. The cost of risk has become a key element by investors while charging funding costs, where in the past funding was used by banks to bind clients to the bank.

    How about Small and Medium Sized Enterprises (SME’s)?

    The alternatives for SME’s are more difficult. According to data from the ECB on the access to finance of SME’s in the Euro area (ECM, 2012c), the share of enterprises which see access to finance their most pressing problem is around 15% of all SME’s.

    In the introduction the reason of the difficult lending possibilities by banks is stipulated. Furthermore, the risk averse attitude of banks in particular makes new increased bank funding difficult. And the Basel III guidelines is another negative factor re lending to SME’s by banks as SME loans are treated like retail loans on the balance sheet and attract a 75% risk weighting.

    That means that any company, which needs to extend or increase its funding base, has to prepare themselves very well and explain in detail the plans for the coming 3-5 years. A good approach is to prepare an information memorandum.

    Probably the simplest other financing sources besides normal bank funding for SME’s are factoring, leasing and supplier finance. But, they need to be very careful with covenants; pledging assets will jeopardise any bank financing. It is key to find the right equilibrium in this respect.

    Another source for small companies is considering to look at crowd funding. In the UK there are already crowd funding platforms where small businesses can seek loans ranging from around GPB 5 k to GBP 1 million. The UK government is using /supporting this platform and will lend a total of GBP 20 million to SME’s through it (Funding Circle).

    In the Netherlands we see that certain platforms are quite successful as well (example geldvoorelkaar.nl).

    Conclusion, the funding sources for SME’s will be difficult for the coming years; good alternatives are not yet in place. It is expected that alternatives will come to the market, but the question is “when”?

    This means that a funding request must be very well prepared and documented. Furthermore, a good equity base is crucial nowadays. A high leverage ratio will in general jeopardise any funding request.


  • Posted on May 20, 2015