Who defaults on Covid loans, with Maurizio Fiaschetti

No good deed goes unpunished and no well-intentioned government loan program goes undefaulted upon, even more so when that government program was designed and implemented in the chaotic early days of the COVID lockdowns.

We've all seen the headlines, but what do the numbers say, what sort of businesses have been defaulting on COVID loans in the UK? Well, Dr Maurizio Fiaschetti is writing the paper on it - along with Drs Ahmed Barakat, Meryem Duygun, Eddie Gerba (PhD), Tian Han, Enrico Onali, Afshin Sabri, Mike Tsionas and Huamao Wang - so I sat down with him to learn more.

You can reach out to Maurizio at https://www.linkedin.com/in/maurizio-fiaschetti-6979073/ to learn more about the research and the publication schedule

If you're interested in studying further at UCL, or indeed in reading their research, you can find the Institute of Finance & Technology at https://www.ucl.ac.uk/institute-finance-technology/ucl-institute-finance-technology

And they're also on LinkedIn (https://www.linkedin.com/company/ucl-institute-of-finance-and-technology/)

Surprise, surprise, LinkedIn is also where you'll find me, and when you do, send me a connection request: https://www.linkedin.com/in/brendanlegrange

My action-adventure novels are on Amazon, some versions even for free, and my work with ConfirmU and our gamified psychometric scores is at https://confirmu.com/ and on episode 24 of this very show https://www.howtolendmoneytostrangers.show/episodes/episode-24

I met Maurizio while in Edinburgh at the 18th meeting of the Credit Scoring and Credit Control Conference - the next one is in two years’ time and it’s well-worth planning for. In the meantime, follow the CRC’s work at https://www.crc.business-school.ed.ac.uk/home

If you have any feedback or questions, or if you would like to participate in the show, please feel free to reach out to me via the contact page on this site.

Keep well, Brendan

The full written transcript, with timestamps, is below:

Maurizio Fiaschetti 0:00

As counterintuitive as it seems, being granted a COVID loan is the single most important factor indicating an increase in the default risk of standard loans/ non-COVID loans.

Brendan Le Grange 0:20

I've just opened Google and typed in COVID loans, and now I'm scrolling through the results of the new section: 'Banks embroiled in row over COVID taxpayer loan guarantee' - Sky News; 'Audi loving fraudster stole £3 million from firm and government COVID loans' - ITV News; 'COVID loan defaults at 40% among mid sized firms' - Construction Times; 'Taxpayer hit by Starlings COVID loans' The Times; 'COVID loans, it's more than I spend on fish a month'...

Yeah, that last one was from BBC News and I was intrigued, too. It turns out they were speaking to the chef and owner of a restaurant up in Yorkshire whose bounce back loan repayments are now a big drag on his business.

But let's not get too deep into the weeds, my point is just that if the various forms of COVID loans are going to leave a single legacy, it's likely to be one of runaway defaults. I've just looked at the UK government's published figures, and only 76.3% of bounce back loan facilities are either fully repaid or are on scheduled to be fully repaid. Yeah, not great. And someone should look into why.

Well, someone did, welcome to How to Lend Money to Strangers with Brendan le Grange.

Maurizio Fiaschetti

, a lecturer at banking and finance at the University College London, welcome to the show.

Maurizio Fiaschetti 1:58

Thank you for having me today.

Brendan Le Grange 1:59

Maurizio, one of the things I'm learning at this conference here in Edinburgh is that there's actually a lot more happening in the academic space then I knew of. I think back to the days that I studied, everything finance was much more accounting or merchant/ investment banking focused, and there wasn't much going on in credit risk. And it seems I've let it slip by me because more and more Universities are turning up delivering courses in this world.

So maybe we could start there with the University College London, the work that you're doing there, and more broadly, any thoughts on the academic programmes and academic research and what us in the professional side of the business should be paying attention to?

Maurizio Fiaschetti 2:37

Yeah, thank you. So I am at the University College London at the Institute of Finance and Technology. As the name itself says, we are trying to adopt the new quantitative techniques in order to to grasp a better sense of what is going on in the finance world. We stress a lot financial technology, but we also stress the real economic side of finance with a particular focus on SMEs, because we know that SMEs are like the backbone of an economy.

Brendan Le Grange 3:06

Yeah, I always love the lending stories for SMEs, because they are that pure side of lending where we helping provide capital to a business that's going to create value

Maurizio Fiaschetti 3:16

The way I see that is a it's a matter of data. So all the credit scoring practitioners know that it's hard to minimise the financial exclusion of SMEs. It's a problem. And since it is a complex matter, universities are trying to assess that matter.

Brendan Le Grange 3:34

And the reason you're here today - and you're here in Edinburgh, indeed - is to talk about a topic that I think many of us have read of in the headlines, and maybe we've got some opinions on, but very few of us have informed opinions on: and that's what happened with COVID loans.

COVID is still fresh enough in our memories. I think we all remember the chaos of those early days, as first weeks when we were convinced the economy was going to collapse, governments around the world made funds available in various different forms. And there was good, we needed support to keep businesses going. But obviously, doing things quickly can lead to gaps in the systems. And in hindsight, they were mistakes made and money was lost.

So I'm really excited to hear your research into who was defaulting on the COVID loans and what you learned by looking at that data. So I'm not going to really structure much of the talk today. I'll just hand it straight over to you: what have you found?

Maurizio Fiaschetti 4:29

Let me start with the usual disclaimer since this is a joint work with many, many extremely valuable people from many institutions, let me say that what I'm discussing today reflects only diversity of views of the oldest, not necessarily the views of the institutions involved. Now, the COVID loans, a two sided coin that had been extremely beneficial in a way boosting the profitability of those receiving COVID loans. But also there are some problems in that.

Of course, they were supposed to be back up for an extreme event, and for that reason they needed to be granted in a very timely manner. Since, you know, most of the loans have been worked through the banking system, many old customers end up having the loan. Okay, so there was kind of inertia granting the loan, so not as many new borrowers. And since whenever you've got cheap money in the line, you can register you can see some other selection and moral outset going on, so that is another problem.

Brendan Le Grange 5:34

The concept of the COVID loans was that some industries were being prevented from doing business benefits were for society as a whole by not transferring the disease. But certain individuals, or certain businesses in this case, were bearing the brunt of the cost and the money was meant to keep them going until they could operate again.

When it came to who took the loans, did it reflect that that certain targeted industries and certain targeted businesses? Or was this just a bit of free money to use in normal ongoing operations?

Maurizio Fiaschetti 6:06

Thank you, this is a really interesting way of looking at our sample. So in our analysis, we were able to see there is an interaction between COVID and non COVID loans, the defaults in non COVID related loans more or less increasing by being granted COVID loans, but that interaction is mediated, if you like, by the size of the firm, and also by the characteristic of the firm itself. So think about that we are in COVID, most of the small and medium enterprises are in trouble, but the smallest and the most in trouble that the most likely to ask for loans.

Once granted the loan, the leverage is inflated, reflecting the increased riskiness on the non COVID facilities. Why on the non COVID facilities? Because the regulation on which COVID loans have been granted are slightly different and are more flexible, and it's easier to default on standard loans.

Brendan Le Grange 7:07

Sometimes, there's only so much you can do and there's only so much impact that loans can have on these businesses. But if we talk about it in actual numbers, what are the ratios of the rest, you have any numbers in that sense?

Maurizio Fiaschetti 7:21

I can give you some numbers, but we shouldn't forget that we are relying on a sample. Okay, so we have been lucky enough to be able to access some proprietary data about COVID loans. The sample is quite good. We could look at roughly half a million accounts, but again, is that finite sample, so it's not the overall universe. So other samples might find something slightly different. So we are reasoning in average terms.

According to our sample the default rates on both COVID and non-COVID loans are higher than expected during the pandemic and higher than you know the standard numbers that we are used to.

We looked at CIBLs the Coronavirus Business Interruption Loan Scheme and we looked at the BBLs (the bounce back loan scheme). So these two lending facilities, particularly focused on SMEs and differences between the two basically is the size of the firms to which they are intended CIBLs are being granted in numbers of let's say £100,000+ for a worth of £26 billion, whereas the BBLs are more than 1.5 million for £47 billion worth is, obviously it's talking about loans, which are quite small 5000 to 20,000. The other ones are under 5 million.

Brendan Le Grange 8:45

It's a valuable pool of data analytics for business loans in general, because COVID was such a wide impact that it's a rare chance to see so many loans less targeted than normal taken at one time.

Maurizio Fiaschetti 8:58

There's a very, very interesting point of view, but also, the problem of accessing data is huge in academia, as well as for policy matters. So from my personal point of view, we will also need to be more open about policies to share data. Anyway, this is food for thoughts for another time.

Going back to what we did, we looked at the default rates for COVID and non COVID loans. The default rates literature, in academia for practitioners is immense, but the results are not definitive in many ways.

So what is driving the default of an SME on a loan? We focused on three potential drivers: the firm's resources, he board level factors, and the loan attributes.

I don't want to bore people going through all the variables that we considered but we have three categories of variables and within the categories we have a bunch of other variables. So what we found basically is the following an increased amount of financial resources and increased size of the board and a longer board's tenure, all these three elements are decreasing the default rate of firms. This is quite reasonable, right? Because more financial resources, job, more sounds, boards, and you're more experienced you, you can weather the storm a bit better.

The size of the board is a bit less intuitive. We are talking about the board size, we're not talking about the firm's size, which plays an extremely important role. And of course, we are measuring the size of the firm. That is another story. But we focus was on the board size wich speaks to corporate governance being important there is a debate about corporate governance, many people make it more complex, but that is helping sharing the responsibility. So you may come a sounder, maybe a more bulletproof decision.

Brendan Le Grange 10:56

Yeah. And I think it also speaks to an organisation that's big enough and specialised enough that you've got a board where each person has got a role.

Maurizio Fiaschetti 11:04

Then there is something extremely interesting about the exposure to the foreign experience in the board. Let me just maybe remind all of us a little bit of context. So COVID, what's something geographically dependent, if you like, I'm Italian, I've been living in the UK for the last 10 years. And I remember extremely well, when I could see COVID coming because Italy experienced that first released back to the UK and other counties.

Brendan Le Grange 11:34

Yeah, I remember the newspaper stories and some poor individual was on the front page as patient zero. He had gone skiing in Italy. And he was the one who brought it to the UK. Obviously, in hindsight, it had been here for six months, the poor fellow's life dragged in the newspaper but at that stage, I think we're naive enough that we had seen it happen in China and said, well, the Chinese authoritarian approach, it's not going to happen here. We saw it in Italy. And then we said, well, it's not going to happen here. And then it was two weeks later, and in a matter of hours, suddenly, schools are closing flights are being cancelled. And the thing we didn't expect to happen would happen, more of us should have seen it coming.

There were many warning flags, but it did still hit us as a surprise, almost!

Maurizio Fiaschetti 12:17

And that's a beautiful way of laying it down, because firms are not so different from people. So coming back to the study, being exposed to the foreign experience made a huge difference.

So just let me give you this as an example, we have two variables, basically looking at the foreign experience of a firm and how they could drive the overall default rate.

One is having a foreign director into the board. So a person who is not UK inactive. The other one is having a member of the board with a foreign address. So with a structural presence abroad. And interestingly enough, we found that having a foreign director drove the default rate up rather than down.

But if that director had a foreign address that was driving down the default rate, why? Well, we have been thinking a lot about that, because again, it is it is quite counter intuitive. But in our view, it has to do with the way the corporate culture is conveyed. So what you need in order to have beneficial effects of the exposure to a foreign component is a structural presence into a foreign country. So not only as he or she the possibility to understand better and to see coming if you like, but also, he or she knows both the words in a better way than the last result, which is also a bit interesting, in our view, is about the repayment schedule.

In the banking sector, there's always this debate with looking at what is called market discipline. So we have seen that more flexible repayment schedule is increasing, if you like the default rate. So if I ask you to repay with a strict frequency, I'm in a way educating you and helping you guiding you towards a strict financial discipline. And I believe that these are these gut feeling. I believe that this is extremely important for SMEs in particular, because you know, bigger firms tend to have a cash and financial management, which is strict and quite more structured. Whereas you can really see that even though they are the backbone of our economy, little bit of financial discipline will definitely help SMEs.

Brendan Le Grange 14:40

Yeah, I mean, that's really interesting to me, and I wonder whether we know if it's different if the borrower asked for the flexibility versus the lender provided, but I guess in either case, the borrower chose the flexible route, but we do normally hear the message that oh, we should be flexible and a lot of payment, holidays and things we're introducing some more flexibility in the consumer world but there is that benefit of discipline that every month and making the certain payment does get you to think in a certain way that's longer term and doesn't allow you to just say, well, we'll sort it out in six months time for now we can have a holiday.

And that's I think transferable learning, in terms of product design, we want the flexibility to react when something happens and goes wrong. And our customer needs us to bend for a day or two and want to say the policy says no, but at the same time, we need to be careful not to become too laissez-faire.

Maurizio Fiaschetti 15:28

Let me give you an example. You know, I'm also teaching and interacting with students, sometimes I've been asked to give explicit deadlines from the students, because they help some of them to be more disciplined, of course, it is not a one size fits all. But it could be an it should be an option. Let's put it like that. So maybe self assess, maybe not we can discuss about that. But it should be an option, because it definitely some firms in this case to be more disciplined.

Brendan Le Grange 15:55

Again, if we think of the way that COVID loans happened, it's less of a planned out credit acquisition process for for a business than a traditional loan would be. It's not that they got to the year end planning and said, well, we need to move in a bigger office or we need to buy a new machine. How much money do we need over what period was high income, they were caught as they were, they didn't have time to prepare. And I think that's also where some of these differences come in, you can make a loan flexible, because your incomes are flexible. And you know, the revenue based lending that happens in the E commerce world, a new business that's growing fast, yes, we need a different approach. But for a generic businesses out there has been operating for five years, that discipline may be the best way, if you can do that. It's because you've got the right team in place, you've got the financial discipline, you've got an accountant and a cash flow management system and all that that's good there. And we shouldn't when we look at way flyer and all the stuff it's doing, like, Oh, I must change my traditional bank and do it everything flexible. It is the there's downsides there. 10 downsides, I think that are not counterintuitive, but not that you would leap to your mind, you know, I would have sat down with COVID loans and you think, okay, there's going to be some fraud and people impersonating businesses, there's going to be some businesses that are on their way out that are just taking their money and running, I would never have thought of things like this. So I think it's a really interesting nugget to pull out of that. And

Maurizio Fiaschetti 17:16

Let me pick up on that, please. Because that is one of the caveats of our analysis, we were not able to disentangle exactly what you just mentioned. So fraudulent activities, we know that there have been fraudulent activities in you know, asking for loans, basically taking the money away. So adverse selection as well. And more lotsa, definitely the the issue is there. But we're not able to quantify that just yet. We are working on a little bit on that.

Brendan Le Grange 17:43

Of course, the headlines are full of people who took a COVID loan here in the US around the world, took a COVID loan and bought a Ferrari or something with it, those cases have happened. But I feel like that probably is a lesser problem than some of the stuff that is quite familiar again, in the consumer world alone that was maybe taken because it was there.

And maybe underlines this idea of discipline, but somebody who wasn't looking for money, maybe they took it, I just thought, well, let's see what we can do with it. Or they thought, well, I don't know what's going to happen in the future. And just in case, I don't know how long I have to close what I'll have to change. And then the money is in the bank. And when the money's in the bank, some people are fine, and we carry on as normal. And other people have the money in the bank. And they think, Well, I don't want to use this and buy a new building to operate out of I don't really need it, but the money's there. That's just me making broad sweeping statements.

And obviously, in a short interview like this, we really can't cover the new ones, but the beauty of academic researchers better says researchers published in great detail and available to read in great detail. So if anybody listening would like to have a look at that, where can they find the research? Where can they maybe reach out to speak to you and learn about what it's showing?

Maurizio Fiaschetti 18:53

Yeah, well, so at the moment, we don't have a working paper, because we are in the process of submitting for publication and doing a little bit more work on the on this and submitted for publication. But obviously, I mean, I'm always there, my public profile, so everybody can reach me out. And I'll be extremely happy to engage. I should have mentioned maybe before but there's also a publicly funded research on Ukri. And we really do care about giving back to the public. So whenever wants to know more be engaged with this research is totally welcome.

Brendan Le Grange 19:28

Great. Yeah. And I'll put the links to your profile in the show notes. They will keep an eye on the research later or know when it's published as well. We were all impacted by COVID. We all have some interest in COVID loans. Boy, that is our money. So there's lots of reasons to follow a spy. I think anybody who's just in the SME lending world, would also do well to have a look at what you found. Well, yeah. Maritza, thank you so much for your time. I'm going to be reading the abstract having a look at that as it comes out from my side. Thank you very much for joining me and yeah, I hope to stay in touch.

Maurizio Fiaschetti 19:59

It's been a pleasure.

Brendan Le Grange 20:01

And thank you all for listening.

Please do look for and follow the show on your favourite podcast platform and share the updates widely on LinkedIn. Plus send me a connection request while you're there. This show is written and recorded by myself Brendan lw range in Brighton England. Show Music is by I am weak and you can find show notes and written transcripts at WWW dot How to Lend Money to Strangers dot show. And I'll see you again next Thursday.

And thank you all for listening.

Please do look for and follow the show on your favourite podcast platform and share the updates widely on LinkedIn where lending nerds are found in our largest concentration. Plus, send me a connection request while you're there.

This show is written and recorded by myself Brendan le Grange in Brighton, England and edited by Fina Charleson of FC Productions.

Show music is by Iam_wake, and you can find show notes and written transcripts at www.HowtoLendMoneytoStrangers.show and I'll see you again next Thursday.