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Bankers Urged to Get to Know Borrowers

Posted by: John Tozzi on February 08, 2010

Regulators want the nation’s banks to get to know their small business customers better. In a statement Friday, federal and state regulators said banks shouldn’t curtail credit based on negative trends in an industry or location. Instead, they should evaluate each business on its own ability to repay. From the statement (emphasis mine):

An institution should understand the long-term viability of the borrower’s business, and focus on the strength of a borrower’s business plan, including its plan for the use and repayment of borrowed funds. The institution should have an understanding of the competition and local market conditions affecting the borrower’s business and should not base lending decisions solely on national market trends when local conditions may be more favorable. Further, while the regulators expect institutions to effectively monitor and manage credit concentrations, institutions should not automatically refuse credit to sound borrowers because of a borrower’s particular industry or geographic location. To the maximum extent possible, loan decisions should be made based on the creditworthiness of the individual borrower, consistent with prudent management of credit concentrations.

Further, institutions should promote a credit culture in which lenders develop and maintain prudent lending relationships and knowledge of borrowers. This culture should encourage lending staff to use sound judgment during the underwriting process. While institutions may use models to identify and manage concentration risk, portfolio management models that rely primarily on general inputs, such as geographic location and industry, should not be used as a substitute for the evaluation of an individual customer’s repayment capacity.

Banks have been pulled in two directions over commercial lending. The Obama Administration and members of Congress have urged them to expand lending to small businesses, but regulators want them to reduce their risk. In this statement, the regulators say they won’t penalize banks for making loans to businesses in troubled industries or locations, as long as the bank has soundly assessed the borrower’s ability to repay.

As a general principle, examiners will not adversely classify loans solely due to a decline in the collateral value below the loan balance, provided the borrower has the willingness and ability to repay the loan according to reasonable terms. In addition, examiners will not classify loans due solely to the borrower’s association with a particular industry or geographic location that is experiencing financial difficulties.

Large banks have increasingly favored credit scoring and computer models over the “relationship lending” characteristic of community banks. Manufacturers in Michigan or builders in Nevada look risky to automated models. But even in shrinking markets, some businesses are growing (possibly gaining share as competitors go under). Relationship lending is more time-consuming, and thus more expensive for smaller loans.

In this statement, regulators are asking all banks to act a little more like local lenders. “The community banks are small enough that they know what’s happening in their local marketplaces, so it’s easier for them to look at that business and not have a problem making a loan that another bank might pass up,” says Sam Thacker, a former commercial loan officer and a partner at Austin-based Business Finance Solutions, which helps small businesses obtain financing.

Thacker told me that with the exception of Wells Fargo, most of the large banks aren’t equipped to evaluate small business loans with such attention. He says he doesn’t even know if some national banks have commercial loan officers in Austin, a metro area of 1.7 million people.

It’s not clear whether the regulators’ prodding will make big banks take a cue from their smaller counterparts. Thacker says it would be a good idea. “I am a proponent of small business being looked at on a holistic basis,” he says. “The bank might need to look at the credit report of the owner of the small business, but they don’t necessarily have to make the decisions to loan on the basis of credit score.”

Reader Comments


February 8, 2010 10:11 PM

One of the strongest banking montra's is "Know Thy Customer". If you know your customer and their industry or business then you will better understand how to advise them in good or bad times. This builds Character for both parties...oh that missing algorithm or is this the philosophers stone?

Prof P.Madhu Sudana Rao

February 8, 2010 10:37 PM

Bank managers at the operations level,will have more discretionary powers in taking an important decision on loan sanctions.Many try to avoid risks and just feel they will receive their monthly salaries if they take risk or not.
There is heavy competition even among the banks for lending because there is more flow of deposits than required.Every loan proposal need not satisfy every rule and security norm of the bank.Because the security they receive as collateral is subject to speculative price movements.The recent examples are gold and real estate price movements.One should keep in mind what happens in the long run and not just short term price movements.
The most important criteria for loan sanctions should be long standing business of the borrowers,his character,his ability to innovation,risk taking,and his other properties and last but not least ethical values.In running a business most critical economic situations may crop up.But his real character will be visible how he behaves when he lost every thing.In harsh economic decision,to solve the problem one should have humanistic mind and not just harsh economic decisions with out bothering about the welfare of the borrower.

Domenick Celentano

February 9, 2010 07:23 AM

Bankers getting to know Borrowers? Hmmm…. It sounds like Target Marketing and Customer Segmentation? I say this with a bit a sarcasm because any MBA understands this; the Retail and Consumer Goods Industries practice this continuously. Don't you think Starbucks and Walmart achieve success by understanding their customers and the unique opportunities each SEGMENT provides?

The problem with banking today is this: they borrow at zero percent and can invest in safe securities to make a good margin. Current policy is a disincentive to loan.

Remember this as well… banks do not sell… they loan. So they have different rules since they have an expectation of getting their money back. Business sells things… the expectation is you will be a repeat purchaser. If the customer does not like what they buy… they have no obligation to return what they buy. Doesn't work that way in banking. Bankers can get their money back in spite of marketing incompetence.

Let's not be delusional in thinking bankers are business people. They are not and akin to attorneys, accountants, etc. They are part of the mix that a business can use to take advantage of opportunities and succeed.

All the best!

Domenick Celentano
Silberman College of Business
Fairleigh Dickinson University

Sam Thacker

February 9, 2010 10:42 AM


The banking phrase "Know thy customer" isn't the same as in the consumer product world as it is in the banking industry. It isn't about buying preferences, it is about lending risk and requirements by the banking regulators that banks be "bad guys in looking for money laundering and such. It is about having as high a degree of confidence that a loan will be repaid.

Sam Thacker

Dave Dickerson, EA

February 9, 2010 01:25 PM

Having been a National Bank Examiner, a "country banker", and a Livestock Loan Specialist for a no longer in existence "big bank", I heartily agree that lenders must get back to consideration of that basic "C" of credit termed "CHARACTER"! Relying on their scoring model and ignoring that basic tenet of lending is one of the primary reasons that "big bank" no longer exists.

Domenick Celentano

February 10, 2010 07:45 AM

Target Marketing, Customer Segmentation and all of the basic principles of establishing a positive Customer Experience are intimately knowing the consumer on an emotional level. Since this is not my marketing class nor the forum to educate in Marketing I will leave the remaining brief.

Credit worthiness is a transactional effort... Customer Experience is transitional. Maybe that is why the Community Banks "get it" and the remaining segments of the industry don’t? You can preach all you want… if you don’t provide a positive Customer Experience, the customer will eventually find another place to purchase… does not matter whether it is a television or a loan. So you might wind up with a pile of cash that no one wants:)

All the best!

Domenick Celentano
Silberman College of Business
Fairleigh Dickinson University

Jerry Chautin

February 10, 2010 06:17 PM

Regulators will get unexpected consequences in their attempts to ease large banks off their dependence on credit scoring. The outcome will include much less small business lending because national institutional lenders cannot afford the cost of full-blown underwriting that small community banks are more accustomed to doing.

Most large banks would rather not make small business loans. They do it for Community Reinvestment Act credit and to steel themselves against criticism from community groups. Many rely on the express loan program from the U. S. Small Business Administration. It provides a 50 percent guarantee against default. So even with a higher than normal default rate, large banks are willing to take the risk in exchange for streamlined processing permitted under the program.

So go slow regulators. You make get what you've asked for.

Jerry Chautin,
Business columnist
SCORE volunteer business mentor
Former entrepreneur, commercial mortgage banker and business lender


February 12, 2010 12:35 PM

Isn't patriot act enough to "know your customers"


Robert Guild

February 12, 2010 05:41 PM

As an accountant who works with bankers on a daily basis, I can say without a doubt that times are changing. Getting a loan from a banker not only means having a relationship with a banker, borrowers will have to demonstrate best business practices.

Robert Guild, Owner

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