Too many hats

Banks can play a vital role in post-pandemic recovery……in their capacity as creditors.

An article in today’s FD caught my attention: “Banken willen belang nemen in worstelende bedrijven” (Banks are looking to  invest in equity of companies that are struggling).

In short, banks are in talks with the Ministry of Finance and Economic Affairs and are contemplating the establishment of a “recovery fund” that is capable of boosting SME solvency. Moreover institutional, governmental as well as retail resources are being considered to join the effort.

The term “recovery fund” sounds very promising indeed, a much needed helping hand in these incredibly challenging times for entrepreneurs.

However, what is surprising is that this fund would a) solely cater for equity investment, b) focus on larger SMEs and c) select only those enterprises that have a bright future ahead, once the pandemic has subsided.

Although there is nothing wrong with depicting viable businesses, the approach by the banks raises a couple of serious questions.

A number of things to unpack here:

Conflicting roles

The most important aspect is the potential for a conflict of interest. The role of a creditor differs vastly from that of a shareholder, in terms of control, governance, risk & reward and accountability, to name but a few items. A single person or organisation is hardly capable of managing both roles, switching hats continuously in the process. Even having these assets managed at arms length is a considerable challenge for any bank. Trying to manage both roles nonetheless carries the risk of an opportunistic approach (not to be confused with opportunity risk). Potential investors should be very much aware of this. After all, equity investors, shareholders, commonly take the first hit if things turn out differently than expected. For instance, when viable businesses turn out not to be so viable after all.

Viable business – in or out?

In the article, risk assessment is being praised (by the banks) as being one of the virtues of bank involvement. The message, banks are perfectly capable of selecting viable businesses to invest in. That raises a couple of questions as well.

First, if banks are indeed eminently suitable for picking the winners, wouldn’t they have done so already? After all, why would there be a need for a selection, if the risk assessment has been right so far?

Secondly, how does one select viable business cases? A recent publication by the IMF that also explored the possibilities of solvency support, explicitly mentioned the challenge of making a meaningful selection, stating that banks and investors would have difficulty in identifying “viable firms under high uncertainty”.  It would be interesting to learn how the initiating banks have resolved this challenge and what eligibility criteria they will be looking to apply.

Sizing up

The intention is to focus on larger enterprises, given the importance of their contribution to employment. That is admirable. However, the majority of enterprises does not fall into this category. The question is, if employment is such an important consideration, then why are smaller enterprises not being considered?

Banking on “capacity”

A genuine effort for recovery is worthy of praise. More importantly, banks can play a tremendously vital role in such an effort, in their capacity as  creditors. This can be achieved by means of debt relief, debt restructuring and business support in the short term. Going forward, banks should be working alongside institutional investment in developing risk assessments and providing SMEs (small and large) access to finance.  This will help develop a healthy, innovative and diverse entrepreneurial landscape, that can make a sustainable contribution to employment.