The current crisis scenario has shed new light on the crucial role of intermediaries in the growth of firms. This has generated interest in the complexity and variety of bank offerings as competitive advantages in their relationships with enterprises. This in turn raises issues such as the intervention levers banks might use to strengthen their relationship with firms, overcoming vulnerabilities and distortions accumulated over time and creating value for both.
On the one hand, the search for a more integrated bank-firm relationship requires banks to adopt appropriate credit risk management procedures on the basis of efficient mechanisms of selection and control of the investment projects of client companies. On the other hand, intervention in new business areas is also important in enabling banks to take on a prominent role in supporting firms, hence shifting the focus to closer relationships and a broader offering than credit alone.
Such considerations have to be further examined in light of the on-going international financial and economic crisis, which started in 2007, and the subsequent revision of banking regulations (Basel III), which featured stricter capital, liquidity and leverage ratios. While contributing to building a safer financial sector, the regulatory requirements have caused banks to adjust their business models, which may present possible negative impacts on lending activity.
In the context of more selective credit policies, the analysis of internal ratings is crucial. Indeed, they play a relevant role in credit decisions, loan pricing and credit risk measurement and management for banksâ internal purposes (in addition to supervisory objectives). In particular, the rating system identifies all structured and documented methodologies, organizational processes and control, which enable the collection and processing of relevant information for the formulation of the risk assessment of the borrower. To this end, banks need to analyse the firmâs long-term growth and profitability opportunities and avoid extreme standardization in the evaluation process. In other words, it is necessary to integrate the results of the statistical methods with qualitative information, which can be collected from a continuous confrontation between the firm and the credit relationship manager (soft information). This particularly applies in times of adverse economic situations, in which scoring models tend to lose part of their predictive ability. Hence, the main critical aspects of credit risk analysis seem to be attributable to the insufficient collection and modest contribution of qualitative data, which are essential for enriching the standardized risk measures. Counterparty rating assessment therefore needs to be strengthened by facilitating the acquisition and processing of all information available and valuing proximity to the market, which can also require profound revising processes of organizational models, decision-making procedures and the connected systems of delegation and powers.
A key factor in bank lending is also represented by the credit guarantees, both personal and real. They are traditionally used as important tools to ease financial constraints, especially for small and medium firms that are often limited in their ability to access credit and to negotiate convenient terms and conditions. The reasons of such limitations could be the scarce reliability of financial statements, short credit histories and asymmetric information: all factors able to negatively impact the most efficient allocation of credit. However, it could be that the borrowers do not have availability of appropriate assets to provide to lenders as guarantees; this is the rational behind credit guarantee schemes, both public and private. Among these, the Mutual Guarantee Institutions play a relevant role as a wealth pooling mechanism, by allowing inefficiently rationed borrowers access to credit.
In recent years, with the advent of the financial crisis and the prudential regulatory framework on capital adequacy for banks, the key role of guarantees in bank lending has become even stronger. Under Basel III (and previously under Basel II) banks can use the credit risk mitigation techniques, if considered eligible as credit protections, to reduce the credit risk associated with an exposure. This inevitably impacts on bank-firm relationships by defining additional opportunities for negotiation between banks and businesses, which rely on the renewed role assigned to the guarantees.
Despite the relevance of bank lending, the prevalent opinion now is that its dominance is one of the causes underlying the slower recovery of the euro-area countries, when compared with more diversified financial markets. There is evidence that during recessions market-based financial systems are more resilient than bank-centric systems, especially when the fall in economic activity goes hand in hand with a financial crisis. Therefore mitigating the limits of a financial system that relies excessively on banks is needed. The aim of diversifying the sources of financing is connected to the need to build a stronger and safer financial system. Accordingly, this will allow the most farsighted banks to support and orient their customer businesses within more specialized and diversified funding sources and consequently to reshape a partnership role with firms. It also involves reviewing the content of bank offerings which (although maintaining the key role of lending) aims to raise new paradigms, according to which banks can draw concrete benefits from a more complex and diverse financial system. Banks could indeed become effective conduits of information on financial innovations, as these are gradually introduced in the field of corporate finance, and strengthen the role of consultant and supporter in gaining access to direct financing channels, with obvious advantages to income levels. Yet lending maintains its central role, especially for small and medium enterprises, for which banks will likely remain the primary source of financing.
The new role of banks aligns with the conviction that market financing should complement, not replace, the role of banks in supporting the economy. Within this new scenario, there is an opportunity to break the vicious circle whereby banksâ difficulties translate into lesser credit or more expensive credit terms and conditions for enterprises. This therefore seems to be the essence of the renewed integration of the banks-enterprises-financial markets.
The new supervisory and market setting still impacts the balance sheets of European banks, in which lending is the primary activity. Moreover, because of profit-related weaknesses and regulatory pressures on liquidity and capital positions, there is a need to intervene in their business models, which could bring value to their core business. First, there is a need to modernize credit risk measurement and management processes in order to try to reduce the weight of impaired loans and hence stabilize the overall profitability. Secondly, there is a need to strengthen relations with business providing tailored support, ranging from the traditional lending and merchant banking to more sophisticated services with high added value.
The book is divided into six chapters including the Introduction. The second chapter âThe bank-firm relationship: how did it change with the financial crisis?â provides a description of the main features of the relationship between banks and firms, by underlining its content, development and prospects under pressure from the international financial and economic crisis. It focuses on the factors affecting the evolution of banksâ lending during the crisis years, by distinguishing between demand and supply factors driving loan growth. Among the latter, Basel III requirements are a key factor.
The third chapter âCredit risk assessment: the internal rating systemsâ highlights the characteristics of the internal ratings systems, considered as a tool both for regulatory and internal purposes. The progressive importance recognized by the regulations (from Basel I to Basel III) has helped to make internal ratings crucial in the processes of credit risk measurement and management adopted by banks. It is important to underline the strengths and weaknesses of such systems, in order to assess their possible impacts on the relationship between banks and firms.
The fourth chapter âCredit guarantees: the role in bank lendingâ highlights the rationale of credit guarantees within the relationship between banks and firms. An overview of the main regulatory requirements the guarantees must comply with, in order to be considered eligible as credit protections, is presented. Then the Mutual Guarantee Institutions, as a mechanism which fosters the access to credit by riskier firms, especially small and medium ones, are investigated. The analysis focuses on the Italian system, on the recent reforms and the connected operational and strategic impacts on the activity of such operators. The chapter ends by describing the role of the Italian Guarantee Fund for Small and Medium Enterprises. Its role has become increasingly relevant in supporting firms with poor credit ratings during the crisis period. At present, however, there is a need for its reform, in order to make the Fund more effective, by abandoning the âcontingencyâ type management which has characterized recent years.
The fifth chapter âBanks, firms and financial marketsâ provides a review of some initiatives, which in recent years have been undertaken both at country and international levels to respond to the urging for a new balance in the relationship between companies and financial market, considered as a whole. Among these initiatives, we particularly recall the creation of the Capital Markets Union, which helps diversify the sources of funding in the European economy. Having more diversified sources of financing is good for investors and businesses and is essential to financial stability, because it could mitigate the impact of potential problems in the banking sector on firms and on their access to finance.
The sixth chapter âIs banking business changing? Some evidenceâ reports the results from a survey on international banks in order to illustrate the intensity and breadth of the changesâmirrored in banksâ balance sheetsâthat has occurred recently and which affected banking businesses. We then shift the attention to the Italian setting and explore the main aspects of the credit risk management processes of a sample of banking groups and report the recent experience of two intermediaries with reference to the content they offers to firms and the related key features.