Companies expected to default on loans as banks go on lending ‘diet’

Mario Draghi: the latest lending averted a crisis. Picture: Getty
Mario Draghi: the latest lending averted a crisis. Picture: Getty
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MORE than half of Britain’s banks expect a rise in the number of companies defaulting on their loans this year amid warnings that financial houses are going on a lending “diet” and won’t be able to drive the economic recovery.

Businesses looking to borrow more money or refinance their loans face “much tougher” conditions being imposed by the banks, according to a report published today.

Lenders are worried that more companies in the services sector – which ranges from accountancy and law firms through to hotels and shops, and accounts for more than 70 per cent of the UK economy – will be unable to make loan repayments this year as high unemployment and muted pay rises continue to squeeze consumer spending.

Car part makers, construction firms and tradesmen are also at risk of defaulting on their debts, the report claimed.

Banks are facing tougher regulations, which means they need more cash in reserve to protect against another credit crunch and the eurozone debt crisis, according to a survey of 500 bankers by accountancy firm Ernst & Young.

A second study, by Edinburgh-based investment bank Quayle Munro, found 38 per cent of Scots firms think their borrowing terms will worsen this year.

The reports come just a fortnight after the Bank of England said the UK’s five biggest banks had missed their “Project Merlin” lending targets to small and medium-sized businesses.

Marcel Van Loo, Ernst & Young’s leader for banking and capital markets, warned: “Banks in the UK and Europe are having to adopt a very conservative approach. They are effectively being forced on a diet – on the one hand they are being asked to hold more capital but on the other they are facing ongoing unresolved macro-economic instability, which is now hitting their loan books.

“Banks are not currently in a position to be the drivers of the recovery.”

Steven Lewis, director of Ernst & Young’s global banking and capital markets team, added: “Many firms looking to refinance are going to find themselves in a tough position this year as valuation adjustments hurt loan-to-value ratios. Faced with higher funding costs and an increase in defaults, banks will have limited room for manoeuvre and will need to impose much tougher refinancing conditions on customers.”

Their warning comes as the European Central Bank (ECB) is this week expected to flood the market with a further €500 billion (£424bn) in cheap loans to help fund the continent’s banks.

The second tranche of three-year loans to banks – known as the “longer-term refinancing operations” (LTRO) – will take the total amount of financial support offered by the European Union to €1 trillion in the past three months.

Mario Draghi, ECB president, said the first round of LTRO lending, in December, helped avoid a banking crisis at the start of this year. More than 500 banks borrowed money from the ECB after losing confidence in lending to each other because of their peers’ exposure to European sovereign debt problems.

The first round of ECB lending was also credited with bringing down the cost of borrowing for some of the countries worst-hit by the debt crisis, including Italy and Spain.