During the last few weeks corporate finance and credit rating have been covering your favorite economic commentator’s schedules who – with an eye on the hard battered Italian banking sector – has tried to collect his impressions about the well researched asymmetric information phenomenon and loan applications from micro enterprises.
Banks must rely on the applicant’s loyalty in sharing sensitive information about an enterprise’s financial condition considering the very nature of almost 90% of loan applications that come from firms with an annual turnover of less than 5 million euros. Having in mind a clear view of adverse selection and moral hazard behaviors in sight, banks select and monitor their loan portfolios with their constantly and market driven revised credit policies hoping for the best possible outcome – i.e. a no-default happy ending. Beside these well documented behaviors is a potentially equivalent condition that can make an economic system cripple, capital allocation efficiency depends on a critical factor: micro enterprise managerial competence.
Ironically, when thinking of a micro entrepreneur applying for a loan at her or his local branch we may characterize her or him as a skilled craftsman but an apprentice at managing a company. The former was, is and probably will be what she or he’s always been good at and won’t be able to acquire and apply the skills necessary to run a successful company. Whereas, the latter of the two may feel the urgence and the need to acquire the necessary skills the former, being clogged up in her or his daily routine, holds back growth. Planning, if any, is mostly cash planning and as the firm identifies almost totally with the entrepreneur, both in terms of capital funded and energy catered, banks find their lending market on rough seas where micro enterprises unreceptively and myopically respond to market changes.
Though topics like “break-even point”, return on equity and investment (epitomized as ROE and ROI, respectively), capital employed and leverage – among the many – are a distant ship on the horizon, the micro enterprise finds its way to a loan application not only during hard times, when for example cash is drained by contraction, but also during the good times, when growth may need to be financed externally. Unfortunately banks know they just don’t have to overcome the asymmetric information barrier but also a managerial one where the company during bad times will likely get stranded or even crashed and realize that empowering their micro borrowers with better corporate finance and more broadly management skills can help make plans work out well.
This is the reason banks increasingly talk about corporate consulting when referring to corporate banking even in the case of micro enterprises in the early stages of existence and survival. Craftsman skills may be needed when the plumbing leaks but a foreman can help a lot to direct them to where the leakage actually is.