Credit Crunch in the UK - Essay Example

Credit Crunch Credit crunch refers to the reduction in the common accessibility to loans or the abrupt contraction of the conditions necessary to acquire loans from the financial institutions. Credit crunch essentially consists of a contraction in the accessibility of loans following a rise in formal rates of interests. In such condition, the connection between the interests rates and the availability of credit has unconditionally changed in such a manner that either the loan is fundamentally less than any quoted formal rate of interest or there stops to be a precise connection between the credit available and the rate of interest. At this point, credit rationing takes place. In most times, a credit crunch is followed by a shift to quality by the lenders and owners of capital as they look out for investments which are less risky normally at the expense of the medium and small sized enterprises (Hull 2). The credit crunch has had an influence on small and medium sized business in various adverse ways. Despite its significant and largely powerful impact, the credit crunch might not be the sole reason for the inadequate success of some selected small and medium sized business enterprises. The growth of the credit crisis will also be taken into consideration as it is crucial in evaluating the way and the manner in which it has influenced the small and medium sized businesses in the dimension it has. As the credit crunch is a very much late feature in the current economy, its growth is frequently varying. Nevertheless, its growth since its inception in the global perspective has been put into consideration. The world economic crunch which started in 2007 was perhaps the most phenomenon shock to ever affect the economy of the United Kingdom to be ever remembered. Ever since the onset of this predicament, so much has taken place that might initially have been assumed to be impossible: The implicit nationalization of two of the largest banks in UK, a state deficit which came in double digits, a depressing grading on the AAA credit rating of the UK, a decline in Bank of England’s base rate which went down to 150 basic points lower than its previous all time low and a programme quantitative easing of £ 200,000 (Heine 27). These phenomenon occurrences have called for essential reforms of the conventional evaluation of the UK economy. As it is a contemporary feature in the current economy it is frequently growing and thus regularly having an impact on all forms of business including small and medium sized enterprises. Small enterprises are identified by their annual turnover of less or equal to £ 5.6 million, total non-current and current assets on its statement of financial position of less or equal £ 2.8 million and 50 employees or less. Small enterprises make up for over 60% of employment in the western economies which puts them especially significant in the present economic condition. Correspondingly, medium sized enterprises can be identified by their annual turnover of less or equal to £ 22.8 million, total non-current and current assets on its statement of financial position of less or equal to £ 11.4 million and 250 or less employees. They are both usually classified as proprietor enterprises, or small family run companies, small consultancies, nascent firms on top of the long reputable business (Heine 67). According to OECD (1), the credit crunch has hit small and medium enterprises harder compared to the large firms. Accessibility to funds and diminished demand are the fundamental elements influencing small and medium enterprises in the contemporary downturn. The UK government has reacted by relaxing the monetary policy, solidifying the banks, promoting lending and availing demand incentive via financial policies. Conversely it is premature to guess which type of policies might end up being effective in the promoting recovery. When financing the entrepreneurs in SMEs find it hard to apply for loans particularly between 2007 and 2010 where the interest rates charged were more than those advanced to the larger firms (OECD 43). Conditions for loans on SMEs consisted of condensed maturities and increased claim for securities. Even though interest rates on loans advanced to SMEs drifted downwards in the entire period of the credit crunch, the rate of interest spread amidst the large companies and SMEs went up, inclusive of the temporary recovery in 2010. The simplest credit terms for huge firms propose that small enterprises were taken to be a higher risk with weak business projects. SMEs in are a critical pivot of fiscal growth, employment opportunities and communal solidity (Clark and Amy 41). As mentioned earlier, the SME’s represent about 66% of all companies. Access to debt financing has been a perennially largest challenge in the establishment, continued existence and development of small enterprises. Evaluation of data from some selected developed nations, the report confirms that business financing to SMEs dropped acutely during the credit crunch and even though it went up in 2010, they later failed to essentially reach the level attained in 2007. Investment and enhancement of capital also experienced a huge drop in the period of study (Turner 213). The reduction in demand for products and services in the course of the credit crunch, jointly with restricted credit terms, affected severely the cash flow and level of liquidity for SMEs which led to high delays in the payment process. Majority of the companies had no option but to declare their bankruptcy which resulted to the escalating high rate of unemployment in many regions of the United Kingdom. This is due to the fundamental fact that the SMEs contribute to the highest level of employment in the United Kingdom. This implies that if the businesses are declared bankrupt or solvent the many opportunities held by the population in the work places are also rendered unavailable given their salaries cannot be met. Credit crunch has also constrained the financial institutions where mortgage backed collaterals are held and securitized debt obligations are also connected to the fall in the housing market. The government of UK made substantial cuts on the interest rates and reduced the reserve ratios and encouraged the banks to convey the same low rates of interest to the households. Given that the country determines the rates that are advanced by the commercial banks, reduce the rates in the inter-bank lending are not substantially passed on to the commercial households. Moreover, and most scenarios more significantly lenders are advancing limited loans. The UK’s credit has contracted for SME’s even though the effect is not yet well established. Fundamentally, the government anticipates that there will be sluggishness in the lending pace hence they seek to prevent it via strategies in their incentive packages (Downs 31). Non-banking institutions and banking institutions are currently strengthening their own balance sheets by ensuring maintenance of enough reserves as a measure of precaution against default and felony. These critical steps have minimized the flow of fresh loaning and the expansion of the current lines of loans in the country. The loan givers are finding it hard to evaluate the validity of the borrowers and their credit soundness in the downturn. A company which was stable in the previous year might turn out to be risky in the current year, specifically if the rate of demand has gone down for their products and services. In addition SMEs with excellent credit background are finding it hard to get the debt financing (HCC 71). The UK has recently experienced a dramatic closure of small business enterprises where 85 closed down on daily basis in the onset of 2009. The closure was linked with the increase in costs, low demand and the lack of the necessary support from the banks. Micro-business enterprises and quite a number of the small and medium enterprises which are not in a position to obtain loans under the current conditions are predicted to remain closed in the course of the crisis. There are some selected small enterprises which are beginning new ventures in sectors and locations where the demand is known to be low. The current projects, essentially those that might be over 75% in the course of completion are probably in a position of completion due to sunk costs and hence the desire to start accumulating good returns. Compared to other nations which are least affected by the credit crunch, the need for venture loans might be higher. Banks in the UK are evaluating some of the proposals carefully (Sayer 13). The fundamental concern for SME’s in the UK is to ascertain that there is enough working capital, particularly where payments for products sold or services rendered are in delay. These comprise partially incisive management of cash flow, strictly monitoring the accounts receivables, making maximum use of the supplier credit and administration of the overdraft services. His has been successful in most countries which implemented programmes to enhance the working capital especially via loan guarantee systems in the constrained economic condition. Consequently, the government established or extended guarantee strategies or minimized the costs incurred by borrowers. For instance, doubling the magnitude of debts enclosed in the credit guarantee system (Oliver and Tony 113). The UK has two main programs which have been initiated for the growth and spread of SME’s. The Working Capital Scheme which gives the state guarantee for 50% of the cost of the short-term debt given by the commercial banks has been initiated. Complete loaning of £ 20 billion shall be granted in a scheme targets firms with a total turnover of £ 500 million or less. Another program is the Enterprise Finance Scheme which applies for small enterprises, with a total turnover £ 25 million or less and will entail a guarantee for a total of £ 1.3 billion loans in bank loaning for working capital or for venture loans of £ 1 Million or less. It can also be applied to translate the current bank overdrafts into loans to loosen up the overdraft facilities (Oliver and Tony 13). Funds given by investment capital finance and business Samaritans has gone down in UK and other countries even though substantial information is not currently available. This type of finance in most emerging nations might not be well established particularly with the small and medium enterprises. The state has taken a position in equity in the banks that are struggling and in few scenarios, in the non-financial firms. These concluding schemes permit a business enterprise to translate loans into equity to grow on its financial status. The United Kingdom has the capital for Enterprise Fund which has the objective of funding the translation of business loan into equity. In this scheme, the state gives £ 75 million and the major commercial banks are granted extra £ 25 million. However, the scheme is available for small and large firms (OECD 3). Credit crunch in the UK has seen a significant decrease in the country’s trade with the world and cut exports from the emerging nations. The exporters have searched liberation in the form minimized financing of export costs. Labor-intensive products from emerging nations have been specifically hurt by the slump, essentially in departments with high presence of small enterprises. Micro-businesses and small enterprises which are established and run by house-holds depend on micro-credit for required ventures and working capital in machinery and tools. This crunch is piling pressure on these operations for lending but quite a lot rely on the features of the micro-finance institutions and its constituent clients. Enterprises that are deposit based are cruising through the credit crunch more excellently as opposed to enterprises that are non-deposit based, which on the contrary depend on finances from the exterior sources inclusive of the State development financial institutions and alien capital origins, inclusive of donors. Funding of these businesses has evolved to be more costly and scarce in the course of the crisis and foreign funds are exposed to more risks such as the exchange rate risks (Mitchell and Arthur 89). The credit crunch has transformed quickly into a challenge of demand and job crisis due to low access to credit for enterprises, house-holds, customers, and insecurity has hindered demand in the UK and highly in other sections of the globe. The Euro Zone economy shrunk by 4.2 % in the year 2009 while the American economy shrunk by 2.8%. Uniformly these two sets of market economies constitute to over a third of the world demand. Generally, plummeting global demand has the potential of causing output go down by 1.3%. The downturn is slowly having a solid impact on trade for the emerging and developed nations. The trade flows went up by merely 2% in the year 2008 and by 9% in 2009 (Ma and Lin 297). During the onset of the crisis many economists proposed that the upcoming countries have evolved into ‘decoupled’ from the established nations and thus would not be susceptible. Small and medium sized enterprises (SME’s), which are export oriented, had the impact of the credit crunch earlier than those which were locally based. The effect has been irregular, for instance, exports from the manufacturing sector from Chinese coastal cities are considerably low whilst the low-end manufactured garments from Bangladesh which distribute discount retailers seem to be moving on well. Exports for footwear and handicraft have recorded a slump. The products scenario is more complicated given that the prices for most products, especially petroleum, food and steel went up phenomenally in the first half of the year 2008 and later went down due to the crunch. Higher cost of food seems to be appropriate for rural manufacturers but has a negative impact on the consumers in the urban areas (Heine 57). A cut in tax can simplify the working capital limitations for enterprises and enhance demand amongst the consumers. As taxes are charged at different stages such as production, value added, income, imports and sales, there is a significant gap for the state to make the reductions. A majority of these steps apply to most enterprises of all dimensions but the State is normally knowledgeable that in most scenarios it will help the SME’s. Tax reductions currently will call for extra taxation in the period to come, which, nevertheless will be highly opposed by the businesses and the taxpayers. Hence the makers of policies require making decisions effectively on the extent of the reduction which might be acceptable and the degree to which debt accumulation will prevent later growth expectations and social expenditure. Variations in the taxation process might have an impact on the formal enterprises yet are probably to have constrained impact on the informal business (GAI 3). It is essential to note that small and medium enterprises in the United Kingdom are critical source of employment and livelihood for most households. As such, as noted from the discussion there is an alarming closure of Small and medium enterprises owed to their inability to access financing or loan facilities from the financial institutions due to the credit crunch that has hit the economy severely. Even the most trusted small and medium enterprises are slowly being neglected by the financial and lending institutions for fear of possible default. This is very risky to the UK economy of which the government has a role to revive the confidence among the lending institutions towards rescuing the falling small and medium enterprises. Works Cited Clark, Maxine and Amy Joyner. The Bear Necessities of Business: Building a Company with Heart. Hoboken: John Wiley & Sons, 2006. Internet resource. Downs, Anthony. Real Estate and the Financial Crisis: How Turmoil in the Capital Markets is Restructuring Real Estate Finance. Washington, D.C: Urban Land Institute, 2009. Print. Government Assistance to Industry (GAI): Third Report of Session 2010-11. London: Stationery Office, 2011. Print. Heine, Christopher. Has the Financial Crisis Induced a Credit Crunch for Small and Medium Sized Enterprises in Germany? Hat Die Finanzkrise Zu Einer Kreditklemme Für Kmu in Deutschland Geführt? München: GRIN Verlag GmbH, 2009. Internet resource. 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The Credit Crunch: Housing Bubbles, Globalization and the Worldwide Economic Crisis. London: Pluto Press in association with GFC Economics, 2008. Print. Read More