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Borrower Beware!

Bank of England
The Bank of England has devised a scheme which will encourage financial institutions to increase their lending to the non-financial sector. The scheme is relatively simple and essentially it means that from the beginning of this month eligible financial institutions, mainly banks and building societies, will receive funding from the Bank of England on the understanding that it will be made available to businesses and house buyers.

It is known as the Funding for Lending Scheme and has the good intention of stimulating the economy. Mervyn King, the Governor of the Bank of England, sought ‘approval’ for the scheme from the Chancellor, George Osbourne, in an exchange of letters on 12th July. The Bank was simply asking the Government to confirm that the scheme was in its remit and that the Government would support the launch of the scheme. The Government did this and, in his letter to Mervyn King, George Osbourne stated that the scheme provided strong incentives for individual banks to improve their lending performance.

In his letter Mervyn King stated that the aim of the scheme was to make loans cheaper and more easily available – hopefully this honourable scheme will deliver. Clearly the mechanisms put in place by the Bank will mean that the eligible financial institutions will be able to borrow money from the Bank at rates of interest below market rates to lend to their non-financial customers. Whether this will translate into cheaper more accessible loans to businesses has to be seen.

Reading the explanatory notes published by the Bank, it is clearly stated that the risk of lending will be borne by the banks and building societies. The Bank has not attempted to stipulate the interest rates that these financial institutions should be charging when making these loans to their customers. Hopefully they will pass on the benefit of the lower cost of this finance to businesses and mortgagees.

I do not expect that this will result in a return to reckless lending by the banks to businesses. They will no doubt want to continue their new prudent approach and protect their balance sheets by making sure that they lend to businesses that have a viable future. The businesses will also want to protect their financial position and should not be led into becoming highly geared companies with the interest charges on these loans seriously eroding the return for the owners of the businesses.

I refer here to the impact of borrowings on a business. A company can be financed by capital invested by the owners, the shareholders in the case of a company limited by shares, and loans provided by financial institutions. Many financial analysts would argue that a company should be lowly geared, that is the value of loans should be significantly less than the capital invested by the owners – ideally a business should not have loans and should be financed solely by the owners. If the loans are disproportionately high in relation to the capital invested by the owners then the interest cover will be correspondingly lower. Interest cover? This is the relationship between the profits generated by the trading of the business and the cost of interest charged on loans.

For many people who do not understand financial information I might now be slipping into accountancy speak which they might find difficult to grasp. However, if you are tempted to pursue borrowings from the bank because of the Funding for Lending Scheme I urge you to take steps to make sure you are able to measure the impact this will have on the financial performance and position of your company. I can help you enhance your understanding of the impact of borrowings during a three hour live online seminar that I am presenting on 25th September.

For details of this seminar please go to this page.

I hope I can help you understand financial information.

Stephen Smith
Managing Director
UK Training (Worldwide) Limited

 

 



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