Bad loans, ECB intervention and competitive advantages

Portuguese companies should not count on ECB intervention to solve the problems caused by the excessive use of debt. The root causes of the increase in bad loans are a lack of innovation and the absence of competitive advantages. The only way to find the path of growth may well be to focus on these drivers.

Here are some facts about bad credit in Portugal:

• 709 thousand individuals are currently facing difficulties with debt service, which corresponds to 15.6% of total – that’s roughly one in every six debtors
• 8.7% of companies are facing delays in their debt service.

Bad loans represent a small proportion of total credit in the economy. In relative terms, bad loans by households represent 3.8% of total, while bad loans by companies reach 7.7% (a sharp increase since 2008). These numbers do not express urgency in resolving the matter on the household side. The level of bad loans at company level appears to be a more pressing issue.

Looking at households in particular, we calculated two indices based on data from the Bank of Portugal: non-performing loans by households and credit extended to households since June 2009.

Bad loans by households are increasing, as expected during an economic crisis. This has not stopped banks to continue to extend credit to households during the same period, as the index shows.

Possible solutions

No-one should count on the European Central Bank to solve the bad debt problem all by itself. The notion that Portugal’s European partners will solve the country’s economic difficulties by injecting money into the economy could lead to disappointment and is in fact, dangerous.

We believe that the answer lies elsewhere: Individuals can be influenced to use less debt but ultimately it comes down to personal responsibility. In the case of companies, the answer lies in good management practices.

The turnaround at company level should come from a sense of purpose, to develop new paths and bet on innovative projects. The reality we see, however, is different. Companies rarely show an ability to develop projects that actually result in competitive advantages. Bad loans are one of the consequences of that inability to forge economic growth.

Companies should use debt as an instrument to finance growth and focus on innovative projects that are assessed and scrutinized by banks. This is a simple principle that would result in stronger companies and a healthier financial system.

Hugo Mendes Domingos Comments on ETV’s Closing Bell, August 8th 2012 (in Portuguese):

The start of a journey

As with every other story we hear now and then, comes one that grips our attention and satisfies our interest about something we never heard before. The Innovation Models blog will take our readers into a journey of understanding, and will also be active in responding to anyone who wants to travel with us.

Among the various issues and challenges in financial analysis, modeling a project or company accurately has become extremely important. The flow of constant information generates too much noise, and it is important to have a guide, a model, so that our decisions can be accurate and efficient. Innovating has become imperative in a world of widespread information, however it is risky to innovate without an overview of the direction that our decisions may take. This is why planning is hard in the case of innovative projects. It is, however, necessary.

Innovation Models will start telling a story that challenges financial analysts and economists alike, introducing innovation as a parameter in financial analysis.  It is our goal to learn as much as possible from this issue and then pass it on to others, so that they themselves can stretch our knowledge further. To do this, we will start writing an e-book that may serve as a guide to those who want to innovate. Starting from basic financing models, progressing to an understanding of the role of innovation in financial planning and ultimately modeling innovation. Our approach will also be an innovative one, we will challenge our readers to participate in the discussion, even when the issues addressed are considered common knowledge. Sometimes questioning the details leads us to more relevant questions, and the discussion, we hope, will make this e-book an interesting read. We count on you to help us on our road to Modeling Innovation.

“It’s a dangerous business, going out your door. You step onto the road, and if you don’t keep your feet, there’s no knowing where you might be swept off to.”  – J.R.R. Tolkien