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Musings of an IP: of rates of interest

by John Harlow, Harlow Insolvency

For months, no for years now, talk in the insolvency profession has revolved around interest rates and correlation between the record low rates and the reduction in the number of business failures. These low rates have been cited many times, together with creditor leniency, as one of the demon causes for the paucity in insolvency work and have resulted in the longest quiet period for the thirty years in which I have been practising as an Insolvency Practitioner (IP).

Much discussion has been had over the emergence of the so-called “zombie” businesses, those businesses which have, for want of a better phrase, been “hanging-on by their fingernails” during the recession, managing to service loan and overdraft interest, but not much else. These are the businesses which were most expected to encounter problems when the economy came out of recession, through shortage of cash and over-trading, a common scenario during post-recession growth.

The emergence of the economy from recession has, however, been painfully slow. The length of the recession appears to have taught business owners to be very cautious and the continuance of low interest rates has meant that the expected rise in the traditional problem areas hasn’t happened…..yet. For the economy, this has to be a good thing, doesn’t it? Well, I suppose it depends on just how strong these businesses really are and how susceptible they may be to a rise in interest rates. The Governor of the Bank of England has been talking about a rise in rates being inevitable pretty much since he started. We all know that it is going to happen; it’s just a question of when and by how much.

The expectation seems to be that it will be by a series of small percentage rises and that it will be introduced over a period of months to lessen the effect, not only on businesses, but also home owners. How much these incremental rises will be, will probably be a reflection on the actual and anticipated level of inflation.

This presents an interesting problem for the decision makers at the Bank of England. I recently read an article on the BBC website by a member of the Monetary Policy Committee at the Bank of England ( http://www.bbc.co.uk/news/business-33955542 ), which warned that any increase in rates of interest may take between one and two years to take full effect. This suggests that any planned hike in interest rates should therefore be proactive rather than reactive and that rates may therefore need to rise earlier than the current expectation. Failure to anticipate the time at which inflation is likely to hit the Government’s 2% target could mean that rates would have to rise quicker than the slower incremental rate preferred.

In order to sustain the recovery, business owners must have confidence in the economy and need a high degree of certainty that there are no nasty surprises just around the corner. The inherent uncertainty surrounding the timing of an interest hike cannot be helping in this respect. Endless speculation over this issue will only serve to stultify growth, due to the caution with which business owners now approach major decisions. Banks are lending again and there are numerous alternative sources of finance available through crowd funding and peer-to-peer lending, although the latter can often be more expensive. Business owners therefore need to know that if they take on additional funding, they will be able to continue to service the loans in the event of an interest hike.

Clearly, if fresh loans are taken-on by a business, but interest rates suddenly increase to a level which it is unable to sustain, then it will have an immediate and detrimental effect on cash flow, which in turn could lead to insolvency.

Whilst the prospect of this could have Insolvency Practitioners rubbing their hands in anticipation, it’s really not what anyone wants to see. Insolvency inevitably brings hardship not only to business owners, but also to employees, suppliers and creditors. Careful management is therefore going to be required in the coming months. Nasty surprises will undoubtedly happen, they always have. The trick for business owners is to be vigilant, to avoid over-extending themselves and to make sure that there is sufficient headroom to weather the unexpected.

I don’t expect for one moment that any eventual interest rate rises will suddenly open the flood gates of insolvency, but it is perhaps worthwhile remembering that IP has a powerful armoury of remedies at his disposal with which to tackle problems should the worst occur. As with all matters, if caught early enough any sudden or unexpected financial crisis can be managed and the business given a chance to survive.

This was posted in Bdaily's Members' News section by Laura Jones .