Understanding bank behavior

 Guest post by Richard Gray

Recently I was reading an article about how the Bureau of Economics is evaluating and changing the way it will measure U.S. GDP. They are working to better capture intellectual property and reclassify research and development as an investment instead of an expense. Today, most of the efficiencies in business are because of innovation in technology and ideas, and valuating these innovations is important and tricky.

Though it’s well known that valuating intangibles is difficult, many businesses don’t understand why lenders think twice when the collateral behind a loan request is intellectual property or something intangible and hard to measure. However, understanding the thinking behind this behavior can help would-be-borrowers prepare so they can be successful in obtaining financing.

People and businesses make deposits at banks, giving the financial institution stewardship of their assets. Banks must be sure they are safe for community deposits. When banks turn around and make loans, they are sometimes risk-averse because they are protecting community wealth, besides making sure the bank’s own business is sound and safe. A bank’s behavior is not just based on its own interests and needs, so decisions are made with the community and economy in mind. Often, financial institutions are fairly conservative.

Financial institutions are an important part of the infrastructure of communities—playing a key role between depositors and borrowers.

During The Great Recession, more borrowers were struggling to pay back loans, and even defaulting. This caused many banks to be even more conservative lenders, in order to protect depositors. However, with the improvement our economy has been experiencing, banks are ready to loan to businesses that want to grow.

Growth might include a loan to buy the building a business is renting or leasing, commercial construction loans, equipment loans, accounts receivable and inventory loans or export loans. Regardless of the type of loan, the bank will determine whether it will lend based on cash flow, credit, capital and character.

How is a loan decision made? When a potential borrower talks to a loan officer about obtaining a loan, it is crucial for the loan officer to understand the borrower’s plan and situation (a few months ago, I talked about what business owners can do to be loan ready). The loan officer does not make the loan decision, but rather, personally represents you, your readiness and your personal character to a loan committee, giving you the best chance for success. The loan committee determines risk—and I’ll talk more about risk assessment and management another time—and makes a decision about how much risk can be afforded.

After getting to know you and your business, the loan officer has to make a case for funding your loan to a loan committee comprised of various executives at the financial institution. Loan officers are your advocates, and the more information you can provide them, the more compelling their presentation will be for the loan committee to approve your loan. The loan officer needs to be able to present clearly the loan request, business information, management character and financial information.

Again, the loan committee will make a decision based on the borrower’s ability to pay back the loan, to keep safe the community’s wealth and facilitate economic growth.

If you’re worried about a lack of collateral, recognize that bankers understand when a start-up doesn’t have any. In these cases, other considerations include management capability, cash flow, owner’s equity contribution and good character. The more tangibles you can put behind your business, the better the loan committee will be able to measure the risk of lending. This is when it pays to have developed a sound relationship with your banker. Banks are the largest lender of debt capital to small businesses and may be one of the only institutions willing to take a chance on an unproven entrepreneur.

If you’re a business owner looking to grow your business, understanding why banks lend to some and not others can help you prepare. Consider the perspective of an institution that is not just taking on risk for itself, but protecting depositors in the community. Understanding this perspective will help you to prepare so that an outside eye will see your business’ potential for good in the economy and as a safe bet for the community.

This article first appeared in The Enterprise.

Richard Gray is senior vice president of commercial lending and SBA lending at Bank of American Fork, Utah’s community bank leader, an Equal Housing Lender and Member FDIC. Richard also manages the bank’s Murray branch, and he has assisted local small businesses in obtaining SBA funding for more than 25 years. He serves on the board of directors for nonprofit Kostopolus Dream Foundation and was the chairman for nonprofit Utah Microenterprise Loan Fund, Salt Lake City.

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