Anyone involved in finance, which in one form or another is most of us, will be aware that the cost of borrowing money has increased significantly over recent months. This has affected mortgages, business bank loans, and the cost of a lease or hire purchase agreements alike.
The starting point for this rise in the cost of borrowing is action taken by central banks in the UK, EU, and USA, to increase their bank base rates and reduce inflation. This is a blunt instrument but the tried and tested policy to slow economic activity by reducing the circulation of money in the economy, this happens in two ways:
- Increasing the cost of borrowing money should reduce demand for all types of credit (e.g. loans and leases).
- Higher interest rates increase the incentive on the part of businesses and consumers to save rather than spend, because they get higher returns on their savings, again reducing demand for goods and services.
From a leasing perspective, changes in the Bank of England base rate and more importantly the market expectation of future interest rate changes will dictate the pricing of deals currently being negotiated. To avoid risks associated with changes in interest rates during the life of finance agreements, most leasing companies fix their cost of borrowing for terms covering the length of their agreements.
These arrangements are known as swaps, these occur when two parties swap interest rate payments with each other. One party (e.g. the leasing company) agrees to provide a fixed-rate payment, while the other takes the risk of paying variable interest payments over the periods involved. In other words, it is what leasing companies pay to financial institutions to acquire fixed funding for a set period. Deals are normally struck by way of ‘block funding’ over several terms (e.g. one to six years) designed to cover the period over which leasing agreements are offered.
Swap rates are based on what the markets think interest rates will be in the future. If they rise, then leasing companies will increase their pricing to maintain an acceptable profit margin. The big question facing such companies is how far ahead to purchase blocks of money at a fixed rate. The safest option is to negotiate swap rates monthly, but in a period of interest rate volatility, this might necessitate frequent changes in leasing prices with limited opportunity to hold prices after quotes have been provided. By negotiating swap rates on blocks of money for several months in advance, it is possible to hold prices for longer but with a risk that by the time deals have been finalised there might have been a reduction in swap rates and therefore an opportunity to offer more competitive leasing prices will have been lost.
It is worth adding that factors other than the cost of money (e.g. bad debt provisions) will influence the price of a lease or loan. It is undoubtedly the case that the long period of rising interest rates we have experienced, coupled with a high degree of volatility caused by considerable economic uncertainty, has created challenging conditions for all of us but particularly for those involved in setting the cost of credit.
Disclaimer
BNP Paribas Leasing Solutions is not authorised to provide tax advice. You should consult an accountant in order to understand the tax consequences of any investment decision.
Andy Milsom, Head of Partner Training & Development at BNP Paribas Leasing Solutions
Andy is an experienced sales and finance professional with over 25 years’ experience in sales aid leasing. Andy is widely recognised as an expert in business finance and has in recent years focused his attention on developing partner sales teams develop an understanding of how businesses secure project financing. His training programme – Finance Unlocked – is a highly rated customisable course and is offered at no cost to partners.
If you’re interested in helping your sales team overcome finance-related hurdles during the selling cycle, please get in touch with Andy on 07966 114 243 or email here.
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