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Tuesday, 2 September 2014

AFM investigates modus operandi of the Exceptional Management departments of large banks, regarding Small and Medium Enterprises. Possible abuse or just common sense?

The Dutch Authority Financial Markets plans an investigation into the modus operandi of the Exceptional Management departments of the large Dutch banks. These departments have been accused of enforcing unreasonable claims on the bank’s customers (mostly Small and Medium Enterprise companies) and unnecessarily pushing them into bankruptcy. 

While I think that abuse of power might have happened on (rare) occasions, I understand that banks have to play for keeps.

The Exceptional Management department (i.e. Bijzonder Beheer in Dutch) of large, modern banks often consists of two branches:
  • A ‘Restructuring’ branch, which helps customers at risk to restructure their credit lines and reduce (the risk of) their bank debt through deploying additional securities, thus helping their customers’ companies to survive enduring economic hardship or a sudden liquidity shock;
  • A ‘Recovery’ branch, which tries to recover as much of a customer’s loan or credit line as possible for the bank. This is the nuclear option, when all else has failed and there is virtually no hope for better times for the customer anymore.

As a consequence of the enduring economic crisis in Europe and especially the longterm reluctance of consumers to spend their money, the EM departments of banks have run numerous extra hours, during the last six years.

Thousands and thousands of Small and Medium Enterprise businesses had an involuntary encounter with this ‘last line of defence’ for the banks. It is recently estimated that roughly 20% (!) of Small and Medium Enterprises is handled by the EM departments, these days.  

Due to the sheer nature of their activities and the ruthlessness that especially the recovery branch must sometimes deploy, in order to recover pending loans and credit lines, this department has become the ‘boogeyman’ of the bank. When a Small and Medium Enterprise customer of a bank has to deal with this department, he is in deep financial trouble.

For quite some time there have been stories of customers – small and medium enterprises in particular – who felt fiercely pressured by this department, or even said to be pushed into bankruptcy by it, while they thought that their company had a reasonable chance for survival.

These customers earlier often felt reluctant to complain at their bank about the exceptional management department, as the bank will not only be their judge, but also their executioner, when things get really wrong.

Such stories about the EM departments were also heard by the Dutch Finance Ministry; consequently, this ministry has now ordered an investigation by the Dutch Authority Financial Markets (AFM).

The following snippets come from an article on the website of  BNR news radio:

The Authority Financial Markets is going to perform an investigation into ‘Exceptional Management’ departments of banks.

These are the departments, which take care of customers and entrepreneurs – mostly in small and medium enterprises – when these cannot meet their terms for repayment and covenants with the banks anymore.

This Monday, finance minister Jeroen Dijsselbloem announced this ‘exploratory’ investigation in a letter to the Second Chamber of Parliament. The investigation will become a part of a secondary AFM investigation into the general service delivery of banks, in particular during the process of credit supply to companies.

And BNR gave some additional oral information, with respect to the investigation into the Exceptional Maintenance departments of the Dutch banks (link is Dutch-spoken):

According to some politicians, the banks are much too strict for the SME-companies, residing at this so-called ‘intensive care’ for borrowers under jeopardy. These are companies, which are experiencing (temporary) liquidity problems – especially on the repayment of their bank credit - and therefore are not able to meet the repayment terms and covenants of their loans. Over 20% of the SME companies is currently at this intensive care.

According to Eddy van Heijum, MP for the Christian-Democrat Party CDA, this puts a brake on economic growth. These companies are now stuck. Banks force them to make depreciations on their assets and to reorganize their company, which these companies might not want at all. Sometimes, the credit agreement is even totally abolished by the bank.

The problem is that companies might not go to court, as they are fully dependent on the banks.

This snippet contains a typical fallacy from a politician, who is solely thinking about the interest of the entrepreneur in question (his grassroots) and not about the interest of the bank (seemingly everybody’s enemy at the moment), which supplied him the money (see red and bold text):

According to some MP’s, like Van Heijum, it is neither due to (for instance) bad entrepreneurship, a flawed earnings’ model, too much risk being taken with borrowed bank money or simple bad luck that an SME company comes into trouble, nor due to the ubiquitous consumer strike in The Netherlands.

No, the reason is that the banks stopped the ‘gravy train’ of easy, low-interest loans and credit lines to these SME companies. Captain Entrepreneur must be worshipped at all times, as he is the genuine hero of the Dutch economy.

Instead of restructuring or withdrawing their credit lines, the banks should have helped these entrepreneurs with extra credit… and more extra credit… and even more extra credit, until the crisis is over and the sun starts shining again for everybody. That would have helped the Dutch economy to find the path to sustainable growth again. Naughty banks…!

These are the same politicians who cry blue murder, when banks come in financial trouble again, due to an excess amount of bad loans.

See for instance SNS Reaal, which was almost annihilated by a stockpile of bad loans and bad credit lines to untrustworthy companies, through its subsidiary SNS Property Finance. By the way, SNS Reaal did hardly have an Exceptional Management department at the time that the problems with SNS PF were mounting. Consequently, they were not able to recover their loans gone awry.

Because this is exactly the reason that professionally operated banks have an Exceptional  Management department: to prevent the banks from falling over themselves, due to excessive bad credit.

Ultimately, even the most professional banks make hardly any profit on their SME loans in total, but the reasons that they are able to limit their losses or even make a small profit on SME loans are:
  • They ask a considerable risk premium on their loans, which seems unfair for the entrepreneur in question, but is necessary to mitigate the substantial, general risks for the banks on such loans.
  • Their Exceptional Management departments are on top of things at this moment, refusing to postpone the inevitable actions at some of their customers in dire straits:
    • Restructuring the credit lines for their illiquid customers, while they still can;
    • Recovering the credit lines when they ultimately have to. 

The fact that no less than 20% of their customers reside at the EM departments of the large banks, proves the ‘raison d’etre’ for such departments, whether you like it or not.

Of course, there might be some cases in which the banks abused their power over the customer and perhaps some SME companies even have vanished, due to such abuse. That is terrible for the entrepreneurs in question; I fully admit that.

Therefore this investigation might be a very good thing for both the SME entrepreneurs and the banks under suspicion, as well as the Dutch MP’s, to emphasize the national rules for lending and show all parties their rights and their obligations.

However, the suspicion that Exceptional Management departments unnecessarily and structurally pinch off SME companies in a draconian way, which ultimately causes the demise of most of these SME companies, is something that I don’t buy…. And that these departments consequently hamper the growth in the Dutch economy sounds also very far-fetched. 

These departments are a very necessary evil in a time, in which the consumers keep their wallets firmly closed and the Dutch economy is yet far from healthy.

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