Ten years after the Lehman crash: what can companies learn from it?
Ten years ago, the bankruptcy of investment bank Lehman Brothers triggered one of the world's biggest financial crises in history. The shock continues to reverberate to this day. The bank's insolvency was the start of a global chain reaction. For companies, payment defaults and delays can start a domino effect that jeopardizes their very existence. This is no reason to be paralyzed from shock, as there are measures that companies can take to prevent this.
Let's look at 15 September 2008. What actually happened at that time? The US bank Lehman Brothers filed for bankruptcy. Like other lenders, it had invested a lot of money in the property market. However, the collapse was not just due to the US real estate bubble but to bankers who had deliberately taken on risks that were far too high. For example, US citizens were given loans even though they did not meet universal creditworthiness standards. In addition, the bank did not follow the standard practice of keeping the obvious default risk on its own books but outsourced the risk to investors. The risky mortgages were combined and sold. Home owners who could no longer pay their existing mortgages were nevertheless given new loans. This meant that banks were able to sell more and more and larger loan packages that basically nobody could afford any longer. It was a billion-dollar market, or as we now know, a million-dollar bubble. But the fiasco was not long in coming. More and more home owners got behind with their payment installments or were no longer able to service their loans at all. Banks were no longer receiving capital from investors. And companies too were rarely getting loans. Step by step, the disaster unfolded and developed into a global financial and economic crisis. According to rough estimates, the Lehman crash and all subsequent escalations caused losses amounting to several trillion euros and adversely affected the lives of millions of people.
Payment defaults in Europe's companies: one step away from Lehman Brothers?
European companies can draw useful conclusions from the bankruptcy of investment bank Lehman Brothers. In the wider context, the trigger was the bank's insolvency. In the narrower context, the chain reaction had already begun with late and defaulting payments on loans held by home owners. For firms, unpaid bills are a risk that can potentially end in insolvency. Of course, the result is not always the collapse of an entire economic system. First and foremost, the collapse of a company has very serious individual consequences for the careers and livelihoods of the company owners and employees. Naturally, this also has an impact on the economy. If you imagine a scenario in which 14 percent of all the companies in a country file for bankruptcy then it is quickly apparent that this sets off a downward spiral. According to data from the German Institute for Applied Insolvency Law, there is no national accounting system to describe losses due to insolvencies, but an annual amount in the three-digit billion euro range is likely.
There are a lot of different reasons for late and defaulting payments. According to the EOS survey 'European Payment Practices' 2018, companies in Western and Eastern Europe cite the main reasons as being missing payments from their own customers (56 percent) and the use of supplier credits (52 percent). Other bankruptcies (41 percent) are the third most commonly stated reason. With regard to the consequences, European companies also paint a clear picture, because no less than 14 percent of European companies had already experienced a threat to their viability as a result of late or even unpaid receivables.
What should companies learn?
Apart from the negative consequences following the collapse, there was also a learning effect. To make sure that there would be no repeat of 2008, the financial sector was regulated more strictly following the crash. These measures include regular stress tests and forcing banks to better prepare for crises. In this context, solutions include the maintenance of stronger equity ratios and the implementation of stricter liquidity guidelines. In addition, the “Volcker Rule” curbs speculation. In the European Union, a banking union was created to afford greater protection to taxpayers in the event of a crisis.
The actual reason behind the collapse was the lack of responsibility on the part of the banks in terms of verifying the creditworthiness of customers when granting loans. In addition, the banks closed their eyes to the risk of payment defaults and passed on responsibility for them, to make money fast. This is precisely where companies should start by making use of these insights.
It is important for business owners to react quickly to payment delays and defaults on the part of their customers. Otherwise they may quickly find themselves in financial turmoil as the result of a domino effect. Obviously, the customer is king. But what happens if this king (or queen) doesn't pay? Every fifth invoice issued by European companies is affected by a payment delay. According to the survey, business customers pay too late in 18 percent of cases, while 15 percent of private customers (consumers) fall behind with payments. Depending on the company's customer group, appropriate caution should be exercised, e.g. by choosing payment methods where there is less potential for defaulting. Other measures, like rigorously obtaining credit reports for credit checks prior to granting payment on account and routinely checking the credit standing of regular customers can point to risks in good time. At the same time, fast action such as sending out reminders is recommended in the event of payment delays. Fundamentally, in the event of a worst-case scenario, it makes sense to work with a professional service provider for receivables management.
Cannot happen again? Wrong!
The global economy got away with some bruised ribs and a black eye. It is well on the road to recovery with stricter regulations in place. The financial world's immune system has been boosted and there will be no repeat of 2008. Unfortunately, this does not correspond to the status quo, because according to reports in the business press there are currently some concerning developments once again. Regardless of the fact that the vociferously demanded tougher controls and regulations are not yet all implemented, never mind effective, the first calls for deregulation are already becoming louder. President Donald Trump has promised to free the banks from over-regulation in order to stimulate the economy.
All we can do is hope that companies in Europe will take self-regulation seriously in the form of efficient risk management and will work with experts in receivables management if worst comes to worst.