In this article, we will try to correct a few of the common misconceptions about banks and about lending. By ‘misconceptions’ we mean those things that can undermine a borrower’s prospects of arranging finance on beneficial terms, because they lower their expectations and make it more likely that they will either accept inferior terms, or give up at the first sign of a set back.
A lending decision is not the collective view of the bank
It is important to remember that most lending decisions are only the opinion of two individuals, at a given point in time – a local Lending Manager (who you see) and at least one Credit Manager acting in a supervisory role (who you do not see). Other people making the same lending decision might arrive at a different conclusion. This explains why, whenever there is a change of personnel at a bank, the ‘bank’s’ view of a customer can then change – people tend to see things differently.
Lending is not an exact science
Lending decisions are not only based on facts and objective information – there is a lot of subjectivity involved too. Other than historic financial information, lenders have very few pieces of objective information about an individual business. Even when they have it, there is an element of subjectivity in its interpretation – for example: was a fall in profits due to bad luck or bad management? Subjectivity also applies when assessing the management abilities of key people, or when reviewing financial forecasts and a businesses ability to achieve them. Things like this have a bearing on the outcome of a lending decision.
Inevitably, this leads to inconsistency in decision making by banks. It is perfectly possible that if you were to take the same proposal to a number of different Lending Managers in the same bank, you would get a range of different outcomes.
To overcome this, you have to do more than just supply information to the bank in the expectation that it will reach the correct decision; you must also be prepared to interpret it for them and help them to understand what it tells them about you, and how your business works. You need also to understand what lending products are right for your business, and why. If you want an overdraft rather than an invoice finance facility then you need to be able to justify why the bank should agree to it.
So do not be fooled by ‘advisors’ who tell you that you will be OK so long as you put forward the right information. That is a reliable sign that they do not fully understand what they are dealing with.
Banks are not all the same
Banks all have different lending policies and rules that will change at different times to match their internal requirements and to reflect what is going on in the wider economy. The banks’ personnel will make different decisions in line with those changing policies and rules.
Banks also have different appetites for some types of business. For example, one bank may have too much property lending on its balance sheet whilst another may still have headroom available, and so the terms they offer for the same borrowing request might differ significantly. What is more, their appetites will change over time: a bank that previously said ‘no’ could easily say ‘yes’ to the same proposal a few months later. It is an ever changing cycle – wheels within wheels.
Some banks also have particular specialisms and may be prepared to consider proposals that others might not.
On a more simplistic note, a bank hunting a new customer will nearly always have a more bullish appetite to lend than an incumbent bank. Surprisingly few borrowers use this to their advantage.
It is not just about the interest rate and the fee!
Too many borrowers still look primarily at the interest rate and arrangement fee when deciding what defines a good offer. We need to get a bit technical at this point, because it is important to know that banks use something called ‘risk-adjusted pricing’, which in very simple terms means that a bank’s profit on lending depends on two key components:
- How much income it receives, and;
- The potential losses it would incur if a borrower were to default.
So whilst the bank’s income depends on the interest and fees it charges, its risk on lending (and therefore the potential losses) will depend on things like the type and amount of security given by the borrower, the type of borrowing facility used , and even on the underlying terms & conditions of the facility. In order to maintain its required return on lending, a bank can adjust either side of the equation; so if it receives less income it needs to compensate for that by reducing its risk on lending (maybe by taking more security), and vice versa.
Therefore, if a borrower puts too much emphasis on the proposed interest rate and fees, then they are only considering one side of the equation. The other side of the equation is just as important. If they thought about it, they may actually prefer to pay a higher interest rate in return for taking less risk, e.g. by offering fewer business assets as security or by taking on a lower personal guarantee liability.
In conclusion
Space has prevented us from going into too much detail here, but hopefully you can appreciate that dealing with commercial lenders really is a movable feast and there are many things to take into account.
If you were to remember only one thing, it should be this: never ride a one-horse race. It is extremely important to approach a number of different lenders when looking for finance, so that you can compare and contrast what is on offer. The same applies when dealing with an existing lender: if you don’t like what is on offer, then look around.
You might also be interested to read our e-book “How and why lending decisions go wrong, and what to do about it”.