The bank-enterprise relationship

The Italian production system, made up mainly of small and medium enterprises, has historically been characterized by a strong dependence on bank debt, with a subsequent need for companies to have stable relationships with credit institutions, based on trust and on a continuous exchange of information.

The trust relationship is consolidated through a constant dialogue and a typically one-way exchange of information, on the economic, wealth, and financial performance of the company, which is necessary for the credit rating assessment in order to grant and/or maintain credit lines.

From the perspective of credit institutions, the reference regulatory framework has been enriched with regulations (Basel 2, IFRS 9, new definition of default, EBA Guidelines), which have already impacted – and will still impact – the credit rating assessment and the monitoring of companies’ performance.

The EBA position, known as Guidelines, specify the internal governance devices, processes, and mechanisms, the requirements on credit risk and counterparty risk, as well the requirements related to the consumer’s credit rating assessment.

In particular, the Guidelines provide instructions on information, data, and other elements – including ESG ones – that credit institutions must consider when assessing credit rating at the moment of granting and/or renewing lines of credit.  

The documentation requested by credit institutions to their clients, regardless of their size (small, medium, and large enterprises), is aimed to reach a – both current and future – detailed overview, allowing the same to assess the clients’ capacity to comply with and repay their financial obligations.

The Guidelines attribute considerable importance to the estimation of future revenues and cash flow – which must be as real and sustainable as possible – deriving from the ordinary management of client enterprises, based on financial projections and on sensitivity analyses of the repayment capacity in case of a worsening of future economic conditions, of the organizational structure, of the business model, and of the corporate strategy.

Such revenue and cash flow estimations are carried out by credit institutions by analysing the financial position, the wealth structure, the composition of working capital, of revenue flow, of cash flow, and of the relevant capacity to fulfil contractual obligations.

Moreover, in order to periodically and constantly monitor clients’ insolvency risk, EBA Guidelines suggest preparing and use specific economic and financial parameters, depending on the type of credit granted.

Companies, for their part, in order to continue such constant trust and exchange information relationship and to avoid their credit to be reduced and/or cancelled, should promptly provide any documentation requested by credit institutions in order to allow them to carry out their investigations.

This is the aim of the important updates under art. 2086, para. 2 of the Italian Civil Code and art. 3 of the Business Crisis and Insolvency Code, which impose companies of any size to start and consolidate the establishment of an own organizational, administrative, and accounting system. 

The rationale under such obligation is to supply companies of a set of instruments allowing them to ensure debt sustainability on a going concern basis and a prompt identification of possible crisis situations.

In this perspective, entrepreneurs need to take many actions in order to comply with the above regulatory updates. First of all, they need to understand what are the internal and external risks which their business activity is subject to and, subsequently, to develop actions aimed to mitigate such risks, including those related to ESG issues. 

From a practical perspective, entrepreneurs need to be aware of their companies’ performance and the main – but not the only and exhaustive – instrument to do it is the budget, which must be prepared on a going concern basis. It must be underlined that the concept of going concern, in the light of the recent regulatory provisions, includes a period of at least 12 months.

The budget must be prepared knowing the risks and the external variables that condition the business activity. For example, in this historical moment, it is appropriate to forecast the economic performance in a context characterized by further increases in interest rates or in raw material procurement costs. Therefore, it is necessary to also forecast the so-called stress test situations (as also required under EBA Guidelines).

Preliminarily, the budget allows companies to provide credit institutions with the introductory but necessary information to assess debt sustainability, thus impacting credit rating assessment.

For example, entrepreneurs must verify whether they meet the requirements provided by the Check list issued by the Ministry of Justice on 21 March 2023 within the “negotiated settlement of the business crisis” procedure.

Therefore, it is now crucial that any entrepreneur supplies their companies with all instruments being necessary to assess their expected earning power, not only for the assessment of their management performance on a going concern basis, but also to obtain from credit institutions the necessary resources to continue the business activity.