Surface Ripples: How Does Deposit Flight Affect My Business?

Tuesday, 9 October 2012

How Does Deposit Flight Affect My Business?

A number of those with whom I work have asked me why it matters to them that some European countries are experiencing a “flight of deposits” to other countries. Here’s the businessman’s answer.

One of the most basic roles that banks undertake is that of financial intermediary between those with surplus funds (savers) and those with a deficit (borrowers). Banks take in savings and lend them to borrowers. Savers are paid interest. Borrowers are charged interest. The difference between the rate of interest paid to savers and that charged to borrowers is kept as profit by the bank.

Banks also borrow in the “money market” from other banks. This is generally at higher rates than those which they would pay to savers. Some of the banks which collapsed during the financial crisis relied more on the money markets for deposits than on personal or corporate customers. When the other banks refused to lend to them, they had nowhere to turn and so had to be rescued or go out of business.

If a bank needs more deposits, it needs to attract savers to place their funds with it. This can be done by paying higher rates of interest. If the bank can’t increase the rate of interest that it charges to its borrowers, it makes less profit. If it makes less profit, people lose confidence and won’t lend to that bank and sell their shares because the bank is less able to generate profits to sustain its business and grow its capital base. In an extreme case, that bank goes out of business.

A bank may be seen as weak due to its own problems, or because it is located in a “weak” country. Banks in those circumstances may see deposits taken out and transferred to banks in “stronger” countries because savers are worried about whether the value of their savings will shrink or that savings may be converted into another currency by government edict. As a result, the bank has to:

· Pay higher rates of interest (reducing profitability);

· Reduce the amount that it lends to borrowers (reducing economic activity and growth);

· Cut costs to maintain profitability (reducing economic activity and growth);

· Seek help from its central bank;

· All the above.

Governments, central banks and other organisations may lend to these banks to shore up their deposit base and support continued economic activity. In Europe at present, the banks in question are often not lending these new funds out, but using them to bolster capital.

If you’re buying from a supplier in a “weak” country or of a “weak” bank, the impacts on your business may be:

· Supplier has to pay a higher price to banks for export finance which translates into a higher price for the goods that you buy (reducing your profitability);

· Supplier may not be able to obtain export finance due to cutbacks by their bank. Either your business’ bank will have to supply credit (increasing the cost of goods purchased and therefore reducing your profits) or (if your supplier has sufficient cash reserves) they may permit you to pay on “open account” terms.

· Supplier goes out of business, forcing your business to seek alternative (and perhaps more expensive or less reliable) suppliers.

If you’re selling to a buyer in a “weak” country or of a “weak” bank the impacts on your business may be:

· Buyer has to pay a higher price to banks for import finance which translates into a higher cost of the goods that you sell;

· Supplier may not be able to obtain import finance due to cutbacks by their bank. Either your business’ bank will have to supply credit (increasing the cost of goods sold and therefore lowering your buyer’s profits) or (if your buyer has sufficient cash reserves) they may be able to pay on “open account” terms.

· Buyer goes out of business, you lose money and may be forced to seek alternative (and perhaps cheaper or less reliable) markets.

Currencies of “weak” countries also fall against other currencies. If you invoice a buyer in a “weak” country in a strong currency, your goods become more expensive and your buyer may buy less or take longer to pay. If the buyer pays higher interest for import finance, this worsens the situation.

If you’re buying from a supplier in a weaker country, goods become cheaper. If you invoice in that country’s currency, your profits suffer as they convert into lower amounts of a strong currency. If you have to supply extra credit, this reduces your profits further due to interest charges.

Some businesses may be able to ignore the impact on their cost base by simply passing their increased costs on to their end buyer. Others aren’t so lucky.

Labels: Crisis Management, Customer Care, Financial, Risk, Selling, Strategy

Surface Ripples

Tuesday, 9 October 2012

How Does Deposit Flight Affect My Business?

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