American banking was functioning well enough before Congress permitted nationwide banking in 1994 and repealed the Glass-Steagall Act in 1999. These two acts led to the development of banking giants, which, it is said, cannot be allowed to fail.
There was a time when banks did what they did best to serve their communities within their trade areas, in a traditional fashion, competently, and responsibly. Commercial banks took demand deposits and made commercial loans. Savings banks took time deposits and made mortgage loans, and neither of the two ventured into fields outside banking.
At a time when the banking industry is under attack, a return to that old-time banking religion may be desirable.
The history of lending goes back 4,000 years with the merchants of Assyria and Babylonia. It developed with banking families such as the
Medici, and evolved with institutional banks just before the discovery of America. The oldest bank in the world, reportedly, is “Banca Monte dei Paschi di Siena” founded in 1472. The constant in lending, however, remains the ability to make good loans, which are repaid according to terms.
Bankers must follow the Prudent Rule. A wise American banker of yesteryear postulated that bankers do not take risks, they only underwrite them. Which means borrowers must assume the risks, for bankers cannot. That is because bankers lend depositors’ money – public money – and, therefore, cannot put it out at risk. Those bankers who do are not truly professionals.
There is another category of lenders, venture capitalists, who, as the name implies, lend private capital to risky ventures. If the ventures succeed, the venture capitalists may reap handsome profits. If not, tough luck.
Pawnshop loans are collateralized by merchandise, which assures repayment to the pawnbroker. Loan sharks take out a life insurance policy on the borrower. Default is not an option. These two categories of lenders do not take risks, even though they operate with their own money.
Unfortunately, sometimes loans go sour, for whatever reason, and then are assigned to a loan adjuster for collection. But when a loan has been made to a foreign entity, the loan adjuster has no recourse. He cannot send the sheriff to collect, let alone the Marines.
It was said that the Soviet Union would not let loans extended to its satellite states go into default. That was wishful thinking.
Before analyzing a loan application, a banker must resolve two questions: Does it make sense? And is it constructive?
A request for the purchase of a large winter-sports inventory by a Florida retailer, or a request for livestock financing in Beverly Hills would not make much sense. (The latter is something I actually witnessed once while serving as an officer on the platform of an international bank branch in Beverly Hills. Two gentlemen, applying for a cattle financing loan, were out on parole, one of the conditions of which was not to set foot in a bank.) Thus, there would be no need to proceed any further.
Of course, not every situation is so simple, and that is where a banker’s experience is essential in making a determination.
A loan to be used for speculative purposes is not constructive, does not serve the community, is inherently risky, and thus should be denied.
After passing the first tests, a loan application must be analyzed according to standard practice.
Every loan application presents different aspects demanding diversified knowledge and experience on the lender’s part. Often times a banker must be specialized in a particular field such as construction, agriculture, or international financing.
A banker, moreover, must be on guard against flimflams and all kinds of fraudulent proposals, because con men have their spiel well rehearsed and convincing answers to any question.
The government is not at all qualified to be in the lending business, in any way, shape or form, and should stay out of it. Its disastrous interventions, under different labels, and at taxpayers’ expense, testify to that.
There is also another, very important consideration. Government officials must be, at all times, above the shadow of a doubt of political favoritism. The government should legislate and supervise banking to protect the public, but that is the extent of its role.
Banking legislation should be clear, concise and adequate to protect the public, but not onerous, and supervision should be exercised diligently, competently and independently.
At the same time, banks should adhere to high moral standards by discouraging people from going needlessly into debt. The concept of “fly now, pay later” does not promote consumers’ financial responsibility.
Credit is credit no matter by whom it is extended and what it is called: A loan, a line of credit, a letter of credit, a mortgage. And the rate of interest charged should remain within the limits of reasonable usury laws.
Traditionally, rates of interest have been tied to the inherent degree of credit risk. If, however, a banker places the burden of risk on the borrower, then, logically, the risk factor does not enter into the pricing of a loan.
Rather, the pricing of a loan should be considered according to the amount of work and time expended to make the loan, and to administer it through its life.
Lines of credit for receivable financing, construction loans, flooring for car dealers, letters of credit, for example, require a considerable amount of time and work by specialized personnel to put together, and then to follow up, sometimes almost daily. These types of credits should be priced according to the commitment of labor and time they require. Obviously this is a departure from the traditional concept of risk-based pricing.
A final word: Banking is an honorable profession of service to the community, not self-serving. It must be above politics and fiercely independent, a role model of uncompromised integrity.
Over his 50-year career in banking, Ugo Nardi worked his way up from a teller to an auditor, lending officer, state bank examiner, and a bank president. He retired in 2000.