When €1 Trillion Is Not Enough

July 9, 2014 Matthew Stammers

1-trillion-is-not-enough

European Central Bank (ECB) announcements are not generally the most riveting of things to read, but ever since the start of the recession in 2008, the headlines have been less Newsnight and much more East Enders or Dallas.

Keeping It ‘Real’

And why is this?

Well, the job of those who run the central banks is to help ensure stability so that companies have a predictable environment in which to plan investments. Therefore, the statements and actions of these central bankers are historically very measured and normally very dull. The idea behind this is not to be the cause of excitement, speculation and hence an unpredictable marketplace. The 2008 recession and breakdown in normal bank lending has left central bankers in a completely new territory. As a result, they are having to take unprecedented action to try and solve some of the fundamental issues in the Eurozone economies.

The €1 trillion promise

The latest ‘fix’ unveiled last week is the announcement from ECB President Mario Draghi releasing up to €1 trillion in lending from the ECB. This action is being taken because, despite historic low interest rates in the Eurozone and worldwide, ‘normal’ bank lending to businesses is simply refusing to recover as banks seek to build their own liquidity. In fact, even in Germany, the most resilient and vibrant of the Eurozone economies, it is only up 1.6% since 2010. Without strong bank lending, companies will be starved of cash and the economies in the Eurozone will continue to falter.

Let’s pause for a minute here to get some idea of what a €1 trillion stimulus looks like. If you took €1,000 notes and stacked them on top of each other, €1 million would be 9cm high, €1 billion, 11m high, and €1 trillion, 100km high (give or take a few cm/m/km). It is a simply staggering amount of money and it gives an insight into the fact that the Eurozone economies, although stable, are a long way from fixed.

Key Insights for Big Business

There are two key insights here for business:

  • The lack of bank lending across the Eurozone will be heavily impacting SMEs access to cash and many of these will be your suppliers

  • The opportunities for investing excess liquidity on the marketplace continues to be impractical with the low interest rate environment

While bank lending is still certainly feasible for large enterprises, SMEs are left with limited financing options. This is critical for large enterprises to understand because their supply chains are made up of a small number of large, well-financed suppliers and a long tail of SMEs.

The big ‘heads-up’ here is that most SME suppliers are under significant financial strain as they have little or no access to bank lending. In other words, the actions your business takes has the ability to make or break your suppliers. For example, undertaking a Days Payable Outstanding (DPO) terms extension, i.e. taking longer to pay invoices, has the potential to put your suppliers out of business. How would the failure of the long tail of your supply chain impact your business’ operations?

Additionally, the opportunity for treasurers to earn a decent return from short-term investments is simply nonexistent. The deposit rate in the Eurozone remains at -0.1%. With inflation at 0.5%, this means that deposits are losing 0.6% in real terms. The only valid reason for investing money in banks is if you need to build a liquidity position for a specific purpose in your business, for example to fund an acquisition. Hoarding cash beyond a reasonable level is no longer strategic.

The New Economy

So while Mario Draghi is busy pushing the restart button on bank lending by promising an extra €1 trillion, the question is: Will this make any difference in the short term? And the answer is probably not. In the UK where there has been an extensive quantitative easing programme, injecting money back into the financial institutions, bank lending is also continuing to decline. Instead, money is coming increasingly from trade finance, which continues to grow rapidly as bank lending falls away.

How Big Business Can Make a Difference

There is in fact an opportunity here for big business, one that will make a real difference to SMEs, which form the backbone of any economy. There is the opportunity to use your excess liquidity (or a third party’s) to invest back into your own supply chain by paying invoices early in exchange for a discount. This will not only release much needed cash back into your small suppliers and strengthen their business, it also gives you a strong investment vehicle for excess liquidity. Instead of earning sub 1% max on the open market, an investment in a supply chain initiative can achieve double digit returns while providing your suppliers with more affordable access to cash.

And best of all, by doing this, you play a role in bolstering the economy, enabling cash to flow more freely and businesses to invest and grow. Now isn't that a nice alternative to learning how to navigate around a 100km high tower of cash!

 
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