Headwinds are gathering for all businesses from rising inflation to the pressures on the global economy accelerated by the ongoing conflict in Ukraine. This impending storm could again accelerate more changes, force some of the shifts needed by business to build their resilience for future crises and could also provide opportunity for private equity and public businesses alike. 

Volume two of The Inflation Shift looks at the role of Private Equity and the impact on European banking.

Private Equity facing challenges and opportunities

Inflation is precipitating several immediate challenges for Private Equity funds. Firstly, interest rate uncertainty and fear of impending recession is having an immediate impact on the cost and availability of credit for M&A. Secondly, portfolio companies themselves are being hit by inflationary cost increases, not only in bought-in goods but also wage demands.

The macro environment is forcing tough actions on both costs (procurement, automation, capex delays) and pass-through of price increases. This can be especially difficult in consumer-facing sectors targeting less affluent consumers who’s disposable income has been hit from energy prices, and now rising interest rates. Available cash is tight, and access to consumer credit harder.

In his article Preparing Your Portfolios for Inflation, our partner leading European private equity practice, Chris McMillan, outlines a checklist of levers to ensure that private equity and portfolio management navigate the new inflationary environment successfully.

Necessary transformation better done outside public markets

For some publicly listed companies, the current environment is causing a scale of transformation which is much better handled outside public markets. Chris McMillan believes that private equity funds’ ability to drive significant and substantial transformations, there could be strong advantages for listed companies going private. 

Public companies could be the target for the next wave of private equity investment in Europe as depressed markets spark a wave of transactions.

Private equity value-added transformation agendas and their ability to bring a long-term vision to the table could provide a unique opportunity for public listed companies to not only “survive but thrive” post the current macro economic shocks.

Read Chris’ interview in private equity News here (behind paywall).

A New Toolkit For Commercial And Central Banks

The banking and financial services system are facing an evolving inflationary environment, having addressed legacy issues (better capitalization, more resilient business models, solid governance practices), and with a central role in society reinforced by the pandemic. However, this does not necessarily imply that the system is prepared for this kind of disruption, particularly since most current bank executives have yet to lead through an inflationary period.

Commercial and central banks must now equip themselves with a new toolkit to navigate this period of high inflation – very different to the one that characterized the last decade of declining interest rates.

For commercial banks, the obvious challenge will be to manage the potential pressure on their bottom line during the inflationary regime (increased credit losses, operating expenses, wipeout of capital gains on securities) and to ensure they are protecting their relationships with customers in the medium to long run.

Banks will need to determine their credit strategies for hard-hit sectors, paying particular attention not to accelerate or deepen the recession. They also need credit strategies for sectors that will benefit from new investment due to the implementation of the National Recovery and Resilience Plan and the post-war resilience plan (tourism, etc.). First movers will be advantaged by developing strong views and sectorial plays in these areas and will be central in helping accompany the new EU economic structure and competitiveness.

To highlight the impact of inflation on the banking sector, we have built three possible scenarios intended to outline at a high level how the macroeconomic situation might evolve over the next couple of years. Read our note on the impact of inflation on European banking and what to do about it here.

Inflation is triggering broad transformations that were pushed back for too long. In future volumes we will continue how the public and private ecosystem could aim for better production, better consumption, an ESG mindsets and transform organizations.