Corporate financial distress and bank lending relationships in Malta

Abstract

In the light of the increasing complexities that local businesses are being faced with, the financial distress problem is becoming more of a reality to Maltese businesses. The relative power of the various stakeholders is important in determining the ability of the distressed business to continue as a going concern. This dissertation examines the way in which local banking institutions deal with the :financial distress problem and the role they play when their clients are faced with such a crisis. Any benefits obtained by local entities through relationship lending, when the business enters :financial distress, were examined. Through relationship lending, the bank will be able to develop an informational privilege, vis-a-vis both the market and competing banks. This dissertation argues that during periods of :financial distress, an enduring relationship with the bank, will prove beneficial not only to the creditor (in that the bank is likely to prove more willing to provide assistance), but also to the bank itself, since the relationship manager will be in a better position to take decisions. An examination of existing foreign and local literature on the subject was carried out. Semi-structured interviews with sixteen individuals were used to gather the information required for the purposes of the study. This study identified the main safeguards against :financial distress that the local banks adopt, that is ensuring an appropriate gearing level, securing their position against appropriate collateral and inserting restrictive covenants in the sanction letter. The dissertation also identifies the procedures implemented by the two banks to counteract their exposure to credit risk, including analysis of figures and ratios, internal gradings, and Credit Scoring Models. This dissertation argues that relationship lending is fundamental to the financially distressed business, in that the relationship manager can obtain a detached view of the situation and offer objective advice to the business, on the best course of action to be adopted. Typical strategies adopted by the bank, such as pressure on management, loan renegotiations, and bridging loans were identified. This study concludes that banks continue to play a fundamental role throughout the whole restructuring programme both directly, when they stipulate what strategy should be followed or given priority, and indirectly, when they act as constraints on strategy implementation. This study also concludes that the introduction of the Company Recovery Procedures in the Companies' Act, is only the first step towards the introduction of a 'rescue culture' within the local environment.