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Banking: It’s the letter K

Author: Daniel Lanyon

Published: 22 Jul 2021

The UK is destined for a K-shaped economic recovery, with the benefits and downsides split between different businesses and sectors, but, finds Daniel Lanyon, the divergence is very much uncharted territory.

For the UK economy, it is a tale of two recoveries. The best of times and the worst of times. You don’t need to get the literary reference to understand just how divergent the economy is as restrictions start to lift. The evidence is everywhere.

In the 18 months of the pandemic, people’s experiences have varied widely. Some have been furloughed while others worked extra hours. Many managed to save extra money while others saw their incomes plummet. Business fortunes too have varied widely with some firms booming and others stuck in the pandemic doldrums and unable to operate normally.

For the UK, like many countries around the world lucky enough to be starting to bounce back, it is looking distinctly like a ‘K’ shaped recovery.

U  O-K?

After an economic crisis and recession, there is nearly always an eventual upturn. But the shape of this can vary considerably. A short sharp crash followed by a quick return to previous levels of economic activity is often called a ‘V’ shaped recovery. A ‘U’ shaped recovery meanwhile starts off in the same manner but takes longer for the eventual return to economic health.

So what does a ‘K’ shape mean? In short, it means some parts of the economy bounce back with ease (the upward part of the letter on the right). Others meanwhile move further into the danger zone (the bottom slanting part of the letter). This is further compounded by an increasing asymmetry of performance. There isn’t really a historical precedent for this, meaning we are heading into the economic unknown.

The implications for banks and other lenders for a K-shaped recovery are profound. For borrowers, it is also starkly worrying.

Nowhere is this perhaps most acutely felt than in the retail sector. While shops have been closed on and off for months, others have seen sales soar. The shift to online has also accelerated, providing further pain for smaller bricks and mortar shops. But the data also show some good news.

The UK retail sector hasn’t just got a spring in its step, but a post-lockdown swagger. Like-for-like retail sales increased 17 per cent in June, compared to the same month in 2019,  according to Susannah Streeter, senior investment and markets analyst, Hargreaves Lansdown.

The headline number doesn’t tell the whole story, however.

Data released by the Office for National Statistics in July show people have returned to stores, but they are shunning high streets and shopping centres. Instead, they are heading to retail parks en masse.

In the week up to 3 July, overall footfall was 72 per cent of the equivalent week in 2019. On the high street though footfall was 65 per cent and shopping centres 67 per cent of pre-pandemic rates. In contrast footfall in retail parks was much higher, reaching 91 per cent of its level in the equivalent week of 2019.

Everything Digital

Another crucial shift, particularly in the UK, has been the rise of digital businesses that have reinforced their pandemic resilience or pivoted to more profitable channels.

A recent report from open banking infrastructure provider Tink, recently acquired by Visa for $1.8bn,  found 56 per cent of UK bankers surveyed believe that a digital shift in banking is permanent, compared to a European average of 41 per cent.

This shift is propelling banks to concentrate their efforts on the creation of digital services, improving the customer experience and restoring profitability.

London’s fintech businesses are booming, recording record revenues and venture capital investment while a number of more mature fintechs such as Wise and LendInvest have made it to the safety of the stock market.

This trend of digitalisation is not confined to banking though. From food to divorces, every sector has seen an acceleration of digitalisation.

Katrin Herrling, CEO and co-founder of Funding Xchange, a marketplace for SME lending, meanwhile says the transition is driven by businesses who have re-invented or shifted their business models to respond to rapidly changing conditions and customer needs.

Rather than the ‘K’ split affecting certain industries, these booming businesses exist in all sectors – including those that have been heavily impacted by the crisis – like hospitality and travel.

Herrling says the firm has found loan performance too is not defined by a sector with winners and strugglers in all sectors.

“Some sectors have done a bit better – for example, agriculture has broadly done better at least where farmers were not supplying restaurants,” she said.

In the first three months of 2021, this prompted the rise of a ‘50/50 economy’ businesses emerging from the pandemic having weathered the storm well and those that did not, equally split.

These firms have been largely unable to access the emergency government funding aimed at halting a rapid rise in unemployment and business collapses. As the broader economy awakens, however, and the same support schemes taper off entirely, the recovery’s survival means these businesses will need to access funding. 

K-shaped lending

Many lenders are pausing credit to determine whether and where to deploy fresh funding. At the same time there is a race to lend to those firms that are performing well, says Tomer Guriel, the CEO of EZBob, which provides digital lending infrastructure to the likes of Metro Bank as well as a number of Tier 2 banks.

“There’s a rush to find the covid resilient business for lenders,” he said.

“Banks have no appetite for more credit. Until the end of this at least you will see a lack of interest for SME credit from Tier 1 in particular,” he added.

Mohith Sondhi, Senior Director, Debt Finance, at OakNorth Bank, says it’s important not to paint all sectors with the same brush as the overarching numbers belie a more nuanced reality.

“Most banks tend to lump all businesses into one of a dozen or so categories – for example, all shops are classified as ‘retail’ – which disregards the fundamental differences in how these businesses operate,” Sondhi added.

The convenience retail market, for example, grew by over 9 per cent in 2020 as a direct result of the pandemic, according to Lumina Intelligence.

“Supermarkets, large online retailers (such as Amazon), and retailers for specific types of goods such as garden furniture and gardening tools did phenomenally well too. Comparatively, retailers who have not embraced e-commerce, so effectively made no revenue during lockdowns, have of course been harder hit,” Sondhi said.

“As we look to the future, it’s important to take this same sub-sector view to determine which businesses are likely to do well and which are likely to struggle.”

North vs South

Geography is also an increasingly important factor in a K-shaped world.

Research by Nucleus Commercial Finance, an SME lender that has seen a huge growth in origination volumes during the pandemic, found more than half (56 per cent) of SME leaders believe the regions of the UK are unequal in terms of both economic growth and prosperity. Just 17 per cent say the regions are equal.

Those in the North are most worried. Nearly three quarters (72 per cent) say the regions are unequal. This compares to one in two (49 per cent) in the South.  More specifically,  78 per cent of those in the East Midlands say the UK is unequal, followed by North West (77 per cent) and Yorkshire & Humberside (69 per cent).

The pandemic has heightened the trend, with 44 per cent of SME leaders saying economic inequality has become more apparent. In the North West, two thirds (66 per cent) reported increased economic inequality.

Back to normal

Now, with restrictions lifting all eyes are on the broader recovery in the economy. Will restrictions lifting help or will there be a lag for those industries badly affect?

The current funding environment, Herrling agrees, is constrained – with most banks and lenders having limited risk appetite as they are finding it often challenging to assess the prospects of a business.

“Traditional risk models have never seen an economy that is awakening from hibernation and has just replaced a year’s worth of revenues with £80bn in business debt,” she said.

“However, the sentiment has been turning much more positive in recent months and it is clear that there are attractive lending opportunities for banks and lenders. Unlocking these will often require digital capabilities to be able to identify and deploy funding efficiently.”

The Government’s strategy to date could be summed up as short term economic damage limitation. In effect by propping up the economy with cash. This curtailed the number of businesses failing and jobs being lost through gargantuan levels of economic stimulus.

The temporary measures are coming to an end, however. Over the next several months we will see most of the government support taper off entirely.

As OakNorth Head of Debt Finance, Ben Barbanel puts it, this will lead to a cliff edge, dividing businesses into two streams: “those which are going to surge ahead and do well in the recovery, and those which unfortunately are not going to make it through”.

For banks and lenders, the priority will be to navigate these uncharted territories and figure out how long the ‘K’ will last while avoiding the hidden dangers and not missing out on the opportunities.