So now all the media pundits are talking about "the credit crunch" as though it is already a reality. It may be, but to what extent? And what is a "credit crunch", how has it come about, and what will it mean for small businesses looking to raise funds to grow?
A "credit crunch" happens when lenders stop lending. The banking system, and financial markets rely on lenders lending to other lenders. When lenders stop trusting their "counterparts" (what banks call other banks), the funds stop circulating at the wholesale level ("bank" to "bank" and in the capital markets), and then they dry up at the retail level. And then you have a "credit crunch".
Why is this happening? In the USA, some mortgage lenders, specialising in lending to high risk ("sub-prime") borrowers, have come unstuck as a result of declining property prices. When the property bubble burst, many of these loans sank "under water" (when the value of the debt exceeds the value of the asset). So with loan books full of loans that were "underwater" and no longer performing, the sub-prime lenders found their own cash flow streams dried up, and some of them defaulted on their own debt obligations. This becomes a "contagion" when the lenders to these lenders (superfunds and banks) have over-lent.
What happens next is that lenders stop trusting each other. Not knowing how much exposure a financial institution counterpart has to "sub-prime" loans, other financial institutions turn off the flow of funds.
In Australia, non-bank lenders have become a prominent feature of the mortgage landscape, and an important source of capital for small businesses borrowing on "low-doc" and "no-doc" terms. If the financial markets stop trusting these lenders altogether, then this flow of funds may be interrupted, causing head-aches for many small businesses.
There are mitigating factors. For years now there has been a large surplus of funds looking for investments. Here in Australia, compulsory super has contributed to very large institutional funds becoming desperate for places to park all the money. I can't see this drying up overnight.
And APRA (the regulator) in its most recent reports on the mortgage industry, says that default rates are a fraction of 1% - well under the high double digit figures experienced in the USA by sub-prime lenders.
There is a credit squeeze - whether or not its a crunch is open to debate at this point. I am not seeing banks closing their small business loan desks at the moment. But even with a credit "squeeze" interest rates will be impacted. The market for money is just like the market for bananas: when there is a shortage, the price goes up. The flow of funds to non-bank lenders will become impeded (how much so is the question), and the banks will become tougher to deal with. Without the non-bank mortgagees applying the competitive pressure we have seen in recent years, the banks will be able to increase their own margins, and to become much more choosy about who they lend money to.
The big questions are: will there be a "contagion" and if so, can it be "quarantined"? My feeling is that given the robustness of our economy, and the points made above, the answer will be "yes", but if you disagree, let me know!
The Cash Flow Ninjas
