About the reasons for high interest rates
By Thomas Otten, Director Otten Consulting
The leaders of many Ukrainian small and medium-sized businesses complain about the lack of affordable financing at affordable rates. Indeed, the interest rates that Ukrainian banks provide are very high (18-22% for loans in national currency). Not every business has such a high returns to pay off interest and still get a decent reward for doing business (profit).
At the same time, European banks provide loans at much more attractive interest rates. And there is reason to be indignant, isn’t it? But this is not a complete vision of the real picture. In this article we will consider what factors affect the business borrowing cost.
A low interest on the use of credit funds means low risks. Business likes stability. It is logical that when someone realizes that the risk is higher, — one want to insure himself. Indeed, in addition to the interest rate, the lender also wants to return his money back, and the higher the risk of defaulting, the more one wants to protect himself. Therefore, an increased rate is a risk premium in our country. What do the risks consist of?
Political and legislative situation
Frequent change of rules, government, political forces, tax rates, lack of rights to private property guarantee, lack of transparency in doing business and corruption — this and much more does not add Ukraine the status of a stable state in which to invest, but it increases the risks of doing business.
It is necessary to take into account the inflation rate of the Ukrainian currency: the value of inflation must be subtracted from the interest rates that banks provide. For example, if the interest rate is 18% and the inflation rate is 10%, then the real interest rate will be 8%. Of course, inflation is not the only factor affecting rates, but this effect cannot be underestimated.
The economy of Ukraine does not have significant development, the level of GDP is low, the country is dependent on imports, as evidenced by the data on budget revenues: in 2019, 29% of state budget revenues amounted to VAT on imported goods. Moreover, any political crises in the state negatively affect the economy.
The state artificially maintains the national currency rate in various ways, including increasing debt obligations. And this is also a risk zone, because at any moment hryvnia exchange rate collapse may follow, which carries additional risks for banks.
In our work, we often encounter confusing organizational structures of Ukrainian business, low quality financial accounting. The main problem is that accounting does not reflect the real financial condition of the business and is not transparent.
The reasons for non-transparent financial accounting may be different. For some companies, this is a way to avoid problems with tax and other inspections or the desire to pay less to the state. Other companies declare only part of their income due to fear of raider attacks.
In general, the reasons are understandable, but this situation does not add confidence to banks in returning money, and these are additional risks of non-return.
Non-transparent accounting does not foster confidence in business planning. The lender needs a reliable detailed business plan, and not just a set of indicators that paint the picture of “Paradise on Earth.” Many times we saw beautifully executed documents promising growth of more than 200%, while sponsors of the draft are ready to invest from 5% to 15% of personal funds, and sometimes even zero. A large financial institution will not study in detail a business plan in which the rates are overestimated or the contribution of personal funds is so low.
Disadvantages of business planning
Even if the financial reports are transparent and reflect good performance, there is a tendency in business planning that draws a “bright future”. Following this tendency, companies do not do themselves a favor, but rather on the contrary, the company does not take into account the weaknesses of the business or the possible risks of the draft. The most important aspect of business planning for an entrepreneur is the willingness to point out the weaknesses of his business and find scenarios for minimizing them. After all, only after compiling a list of weaknesses does it become possible to describe how they will be addressed. It is necessary to stop writing “beautiful” business plans, you need to work in detail on the weaknesses of your business. Only such planning will allow to outline a realistic picture and goals that can be achieved.
Risks of informal loans
Due to the inaccessibility of bank borrowed funds for many companies, Ukrainian business is looking for other financing options. In this situation, the German proverb “The cat bites its own tail” is very appropriate, because informal loans are, in most cases, more expensive than a bank loan. They carry great risks when conducting inspections by regulatory authorities and may even result in blackmail and extortion.
The situation with lending in Ukraine really has a lot of questions — from the quality and solvency of the borrower, his plans and prospects to more global problems at the state level, which business cannot influence, but which have an impact on high lending rates. The inaccessibility of borrowed funds reduces business opportunities, while other options for attracting financial resources remain, for example, the search for investors, including foreign ones.