Banking Industry – Overshoots then Undershoots – again.

by Michael Royal, BIR

banks love to lend when you don’t need the cash

When times are good, banks fall over themselves to lend you money. They can’t shovel their money out the door fast enough. They encourage and support broker channels of distribution as well as their own shop fronts and the newly formed

When times are tough, banks are playing it tough too. Just when businesses need their banker’s support and a ‘relationship banker’, the relationship is at near breaking point for many businesses. Just like in the late 1980’s and early 1990’s.

At BIR Finance, we have seen many nervous relationship bankers in the current climate. They don’t know which way their senior management is going to turn next. Flavour of the month is risk avoidance – if you don’t lend then you can’t make a mistake. It’s just a pity these same senior managers didn’t support this strategy during the good times.

So what do banks want from borrowers today? More on this later. First, let’s have a quick look at how and why we are in this current financial mess. As history has a habit of repeating itself, so the lessons to be learnt today will prove invaluable next time round.


It is fair to say banking is a ‘must have’ industry for a properly functioning capitalist based society. At its most basic, banking allows the distribution of money from those who have it now to those who don’t have it but who need it now.

Those who ‘have money now’ are the savers in our community (perhaps those who are frugal or who are saving for a particular purpose and also higher income earners) and those who ‘don’t have money now’ are the borrowers (for personal finances, homes and businesses). Without banking, our level of economic growth would be undoubtedly lower (perhaps that would not be such a bad thing given the economic and environmental mess we are in!).

Banking is not sexy and it is not complicated. Its almost guaranteed return on investment has possibly been one of the reasons why bankers have had to bear so many negative stereotypes over the centuries. The perception is they can’t lose – only you can!

A bank’s business model is simple: it borrows money at one interest rate (its cost of sales) and it lends it at a higher rate (its sales price) and, to minimise its risk, it takes some form of security (often in the form of property) over its borrowings in case things go bad. And, the individuals behind the loans tend to bear the ultimate financial risk if the security is insufficient to pay the bank back in full (except of course in the USA where individuals can and do walk away from their bank debts when the value of their security falls below the value of their loan).

As there are only a limited number of businesses which can conduct banking activities, a bank is unlikely to go out of business if its sticks to this simple deposit/lending model. And, even with the reduction in restrictions on new bank entrants, the huge cost of infrastructure required to set up a full service new bank means that it is unlikely new banks can ever replicate the geographic and demographic spread of the large, well established existing players. (A number of new entrants from overseas have tried and failed since banking deregulation in the 1980’s).

With the inability for new entrants to take on the existing banks, the incumbents are in a privileged position with their customers.

It is therefore arguable that banks have a duty of care to not only their shareholders (which they are always keen to point out) but also their customers, who, once ensconced with a bank, are often faced with a myriad of difficulties if they wish to change banking suppliers – from switching costs, time and to expertise to understand the pros and cons of the various banking products (unlike the supermarkets where standardised unit pricing is now becoming common, the task of comparing the cost of banking is fraught with difficulties).

However, it has proven difficult for many of the major banks to stick to their knitting, especially since deregulation saw the introduction of many forms of banks other than the full service major banks. The proliferation of non banks who can lend you money has further eroded the confidence of senior bank management to stick to their knitting.

Unfortunately, the senior management of the major financial institutions, possibly driven by the thought of large salaries and even larger bonuses and a misguided vision that banks should have a return on capital much more akin to a higher risk business than ‘simple banking’, have allowed their businesses to get into this current financial mess. And we, the customers have to bear the brunt of their past decisions.

It is not too far from the truth to say if you did to your own business what they have done to their business, they would call you reckless, they would claim you did not understand your industry and they would not lend you a cent!

These senior banking executives, like lemmings, almost deliberately go down the path of over-lending in the good times (all in the name of increasing market share and shareholder returns but probably more than just a passing thought to their bonuses), even though they know that there will inevitably be a retraction at some point in the economic cycle. In the bad times, they under-lend (all in the name of risk avoidance – but this horse has of course long ago bolted), again knowing that there will inevitably be an upturn at some point in this same economic cycle. This creates a roller coaster for the rest of us. Thanks (not!).

If banks stuck to their knitting of deposit taking and lending to home owners and businesses on a stable full cycle basis, we would not have to go traverse this financial roller coaster and the banks would be consistently profitable (as they should be) with a low risk rating. But they don’t stick to their knitting.

[You can see why recently some economists recommended that the Commonwealth Government set up a new State owned bank which dealt in only ‘core’ banking products. Such a bank would serve the interests of every day Australians by sticking to the knitting of deposit taking and lending.]

So, now that the banks have been burnt, many have turned their back on privately owned businesses as these are less visible than home borrowers. They charge businesses high interest rate margins, they are deleting much needed financial products (witness the recent withdrawal of ANZ Bank from the Invoice Discount Finance market) and they have reverted to bricks and mortar security to support business working capital needs.


We are back to the days of bricks and mortar as security for business loans, supported by a fixed and floating charge and of course director’s guarantees.

Working capital is no longer a good risk for many banks (we are finding a few that will lend on working capital and fixed assets other than property but this is certainly much less common than it has been).

As long as the above is taken into account, the 4 C’s of any finance proposal still hold true:

Character – given your history, would you lend to you? (Think trust and respect, past credit history).

Cashflow – does your business support paying the interest each month on time and then the principle? (Think net operating cashflow before interest).

Collateral – what do you have as security in case things go wrong? (Start thinking property, not just working capital assets and fixed assets).

Capability/Commitment – is the right structure and people in place to minimise the business risks? (Think about your business, its competitive advantages, your business plan, financial forecasts, the expertise of the people in your business).

Things banks don’t like:

Missing 4 C’s – particularly collateral – this will kill the deal every time. The lack of future profits in your forecasts is also not a good start (although I have yet to see a forecast prepared for borrowing purposes that did not show a profit and the ability to pay back the debt in full and on time).

No skin in the game or hurt money – all financiers including banks like to see the ultimate beneficiaries invest some of their own cash into the business.

Historical losses – even if things have turned the corner.

Tax arrears – owing money to the Australian Taxation Office other than your current BAS, even under an agreed repayment plan, is a no no – as is superannuation arrears and suppliers who are owed money for more than 90 days).

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