In its October Financial Stability In Focus report on the corporate sector and financial stability, the Financial Policy Committee (FPC) looked at how effective the financial sector was in channelling finance to UK businesses and households. The FPC said it was concerned with how the financial system can 'best intermediate the supply of finance for productive investment'. 

Risk rises as debt worsens

A graphic in the report demonstrated the cyclical and linked nature of losses to businesses that were passed on to banks and financial markets. These losses worsen as debt in the economy increases or matures beyond payment schedules. This in turn tightens credit conditions and disrupts financial markets, which magnifies in a feedback loop to businesses.

Households also suffer as employment changes and real economy inflation cause strain on borrower resilience, retail credit and mortgage lending, which in turn is passed back to banks as higher defaults and loss of business. This second feedback loop also contributes to reduced UK GDP and amplified downturns, including small business lending.

End of government stimulus

Outside of the report, the Bank of England (BoE) is taking into account the end of the Coronavirus Jobs Retention Scheme (furlough) and the beginning of repayments to banks from businesses from the Bounce Back Loan Scheme and Coronavirus Business Interruption Loan Scheme (CBILS). Increasing unemployment and rising business payment defaults on these loans to banks could cause mounting losses and a tightening of credit conditions, as the FPC fears. 

To add to the complexity, the government coronavirus loans schemes are based on guarantees, which means the banks must show they have taken every step to chase any payments, which could delay government payments to banks 

One member reported to ICAEW that many of the loans were completed at speed and online, and sometimes the paperwork had been mislaid. “Trying to recover it from the banks has been administratively difficult,” they said.

The first year's interest on the loans is paid by the UK government and so is effectively another loan, which can be overlooked, said the member to ICAEW.

A Federation of Small Business (FSB) Area Manager spoke to ICAEW, and said many of the small businesses they represented saw credit ratings reduced if they took any of the government loans, or furloughed staff, making it difficult to access further lending.

Rising prices hurting small business

Many ICAEW members have reported business disruption in the past few months, which is adding complexity to revenue generation and stressing their liquidity. When speaking to ICAEW in early October, a number of London-based ICAEW members expressed surprise at the position of the central bank over inflationary risk. They stressed that the rise in wages could become entrenched, and less likely to settle down as per the price of raw materials.

One northern member firm, serving several engineering businesses, observed that their clients were reporting distress from the all-time high cost of steel, as contracts did not allow them to pass on the costs.

Consultants in the South East reported a rise in business looking at the resilience of supply chains and making them more resilient.

Meanwhile, an ICAEW member manufacturing client in the West Midlands has seen price increases in its raw materials of 300%, while its energy costs rise by 75%. This comes at the same time as the firm is forced into giving a 5% pay rise to retain staff, as recruitment of new staff is proving difficult.

Finance issues

While businesses absorb inflationary price rises in materials, costs and wages, the ability of businesses to borrow, especially those in the construction industry, appears to be diminishing. One member told ICAEW that volatility in raw materials means funders are not keen to provide new finance facilities. Existing facilities are being honoured, said the member client, but they anticipate pipe-flow business for new projects dipping in the future as a result of the drop in available new financing.

You can access more resources on the issues raised in this story via the links below:

• Business rescue
• Cash flow and forecasting