There has been constant yammering in the media from the side of the government and their desire to implement projects through the Croatian Bank of Development as soon as possible and the terms of these loans that are to be granted have to be extremely giving to struggling businesses. The request is for loans (in doesn’t say the term of these loans) to be granted at low as 1%. This type of logic ensues because the banks aren’t granting loans to businesses and the subsidy has to kick in.
Is somebody asking the important question: Where are these funds going to come from? Any if they are granted through these banks, that means that we are dealing with a balance sheet. And if we are dealing with a balance sheet, that means profit and loss dynamics are in order. So – loaning out at one percent, eh? What are the investors getting? 0,5%? Less?
It seems that there aren’t enough savings first of all to support this kind of loaning. If the banks were flush with real liquidity (not shadow savings aka inflation), then I would have only the objection of loaning through a privileged program to an anointed few.
This time, we have no savings (probably government borrowing at 5 and more percent) and loaning this out at one percent. Brilliant. Second of all, the simplest way you enter a project is to determine your weighted average cost of capital if you have decided on a complex capital structure or just the marginal cost of debt if you decide to do it with a loan. The interest rate is of extreme importance, because it shows the temporal structure of the endeavor. If for example I were to decide to discount my future cash flows at five percent and then discount those same cash flows at a different rate (assuming the initial cash flow for the project – the outflow – was same in both cases) I would get two different net present values.
A positive one with a lower rate and a lower,even negative one, with a higher rate. If I use subsidized loans and enter the project, assuming certain cash flows and demand for my project I would be dumbfounded to realize that my project would add value, when in reality I would be suffering a loss. What happens when during the course of the project, interest rates (market rates) rise and I am left without cheap borrowing opportunities? I would be forced to liquidate my project and salvage whatever remains of it. This course of action usually occurs in a inflationary credit environment when credit is “easy” and in “the streets”. Projects are valued more than they should be and assets are grossly overvalued.
When the gravy train leaves and the interest rates give a realistic picture of the available funds in the economy or that a splurge of demand is brought to a halt, panic sets in and the company can declare bankruptcy.
Along with the development bank….
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