Commercial Banking –What is Going On?

Access to credit can mean the difference between life and death for many businesses. The financial crisis has caused a great deal of change in the banking industry and, unfortunately, this can mean trouble for many businesses. Ask yourself a few questions. Does it appear that your bank is being very cautious about credit commitments? How does your bank decide credit issues? Do you know the risk rating assigned to your company by your banks regulators? What can you do in these uncertain times to improve your chances of getting the credit your business needs? The answers to these questions can dictate the survival of your company.

Commercial banking has changed a great deal in the past couple of years. Financial institutions now see capital preservation as a primary factor in doing business. Many banks use some form of profitability model to determine whether or not a customer adds to or subtracts from existing capital. One common method is called the Risk Adjusted Return on Capital (or RAROC – pronounced “ray-rock”). Essentially, the bank will assess how much a customer brings to the table with interest revenue, fees, and deposits. These are capital additions attributable to the customer. Financial institution regulators require a bank to set aside more capital as a reserve when the risk of loan default increases. As the customer’s profitability and cash flow becomes impaired and more capital must be reserved, the bank is forced to reduce its available capital. The loan loss reserves coupled with any specific costs associated with the relationship are capital reductions. The bank knows how much capital is required to run the business, so this type of profitability model allows the bank to calculate the relative contribution or cost a customer creates. Knowing how the bank calculates the value of your relationship can be very important.

When a line of credit is renewed, it often will pass through a credit committee of some type within the bank. Depending on the amount of the credit, the review may be limited to several credit specialists or it may go to a formal committee with numerous bank officers and in-depth debate of a customer’s financial position. The key to successfully navigating this process lies in preparation. Your banker will put together a package providing information to the credit committee on relevant factors supporting renewal of the credit line. The more he or she knows to support a positive decision, the better your chances. Prepare a written business plan using realistic assumptions and trends. Accurately project your capital needs and cash flow. This meeting is one of the most important that your business will be involved in each year, so make sure that the bank has the best information that you can provide.

What does this mean to the finance executive in business and industry? It can explain why some banks, particularly the larger ones, are focused like seldom before on interest rates, fees, deposits, etc. It can also explain why that drop in cash flow or recent loss on the financial statements from last year is apparently now a much bigger concern than had been anticipated. Many bankers believe that the best way to mitigate problems caused by any downturn in your business is to communicate openly and frequently. Make sure you monitor every covenant required by your loan agreements. If you believe that a covenant breach is likely to occur, be sure to discuss this with your banker as early as possible. Bankers hate surprises. If brought to the banks attention early enough, it is possible that a covenant waiver can be granted by the bank. Although a waiver fee may be assessed or the interest rate may be adjusted, these options are preferable to a loan violation leading to default.

Your best interest will be served by knowing as much as is possible about the banking business. Understanding the bank’s regulatory environment and how banking decisions are made will allow you to put yourself in the banker’s shoes. You know your business better than anyone does. You can improve your chances of getting the credit you need if you can anticipate what the bank will need for good credit decisions. Working collaboratively with your banker to get the most from your relationship is usually the best way to ensure positive results.