“ Credit “ – It’s all a matter of belief

This has spawned numerous words in the English language such as Incredible ( unbelievable ), Creed ( belief ) and Credit ( believability ). Considering everything that is now going on in the financial world, it is particularly important to remind ourselves of the true meaning of the word “ Credit. “ If a bank or business extends credit to another business, it is basically saying that it believes in both its ability and its willingness to pay what is owed on time and in full.
The whole geo-political and business world relies so much on credit these days that major reverberations are felt whenever it is undermined. Take, for instance, the current banking crisis in Spain. Much of this has been caused by the collapse in the value of Spanish residential and commercial property prices. Institutions who have lent money to Spanish banks are understandably concerned that their balance sheets, which reflect their ability to pay their debts, are not as sound as they appear on paper. This undermines both their credibility and, ultimately, their credit ratings. This, in turn, affects their ability to borrow new funds and the interest rate they have to pay on them.
In a situation like this, the only way to restore confidence and creditworthiness is for an independent third party to conduct a full audit of the banks’ true financial situation.Let’s take a hypothetical example of what this means in practice. The Union Bank of Sangria ( UBS ) has been an active lender to developers of apartment blocks and has extended loans and overdrafts to these customers to the value of 10 billion Euros. The bank claims that these loans are covered by 12 billion Euros worth of collateral in the form of property assets i.e. enough to leave a surplus of 2 billion Euros.

What is worrying the banks that, in turn, have lent money to the UBS is that they no longer trust its assessment of the value of the property it holds on mortgage. If they read in the newspapers that estate agents are saying that apartment prices have halved while the UBS are claiming they have only fallen by a quarter, they tend to get very nervous indeed. Maybe the bank, in reality, has a deficit of 2 billion Euros rather than a surplus.

So serious did this erosion of confidence become, that, in the end, the Spanish government itself had to intervene by organising comprehensive audits of all the banks based in the country. Only then were financial markets satisfied as to the true status of the banks’ loans and the collateral securing them.