Banks May Ask Why They Should Lend Anymore

Amid all the complaints that banks are not making enough loans, one can build an awfully good case for asking why banks should make even as many loans today as they do.

Look at some of the reasons:

* Undoubtedly, the most important lesson that bankers have relearned from the present period of difficulty is that a few poor loans can kill a bank. In college, 90 correct answers out of 100 win an "A." In baseball, a .300 batting average is considered excellent.

But in banking, 99% of the loans must perform for the bank to break even - since the well-performing bank earns only about 1% on its assets. As saddened lending officers report, one bad loan can sop up the earnings on 99 good ones. No wonder bankers are cautious in today's poor economic environment.

* In many instances, the reason banks are not lending is that potential borrowers have forgotten they themselves must put up a decent percentage of the funds needed for a project.

Borrowers got spoiled in the 1980s, when many banks would lend not only 100% of the funds desired but also enough to cover up-front fees and the first couple years' interest payments. Borrowers should admit that bankers no longer are willing to lend on borrowers' terms but are going back to the basics.

* Bankers have learned to their sorrow that it is far easier to make a loan than to get their money back, even when a bank has devoted extreme caution to structuring adequate collateral and protection into the credit.

Personal bankruptcy is no longer the stigma it used to be, and its use has soared. Moreover, in corporate bankruptcies, many judges have put continued operation of the company above creditors' rights to foreclose on assets pledged as collateral.

When a bank tries to enforce agreements that borrowers have signed, the borrower is likely to respond: "Take a small percentage of what we owe you and release the collateral, or we will go to Chapter 11 and you will get nothing."

Who would want to lend with this blade hanging over his head?

* When banks have made loans, they have often been subject to lender liability suits as they tried to collect what is their due. While ever fewer of these lawsuits are being won by plaintiffs, banks still incur heavy expense in defending themselves.

On top of this, banks have found that, when they do reclaim collateral, the property sometimes fails environmental tests, for which the bank is held liable.

Throw in the fact that, under our new risk-based capital requirements, banks are far better off buying investments than making loans, and one can understand why the percentage of bank funds placed in investments is soaring and the percentage lent out has fallen to the degree it has.

And one can add here that the cost of putting investments on the books is an awful lot lower than the cost of sending out lending officers to evaluate a proposition and then preparing a loan agreement.

Blaming the Victim

Businesspeople, lawmakers, and other outside observers ask: "Why hasn't the ready availability of credit and reduction of interest rates encouraged more lending in the way that the administration had hoped?" One can answer with the basic tenet taught in the first weeks of a money and banking class: "Federal Reserve policy is like a string. It can pull, but it can't push."

No amount of credit easing can force a borrower to seek a loan if there is little prospect of using the borrowed funds profitably. And no amount of credit easing is going to encourage bankers to lend when getting the money back is so difficult and when placing the money in safe, government-backed investments is so attractive.

Arthur F. Ryan, president and chief operating officer of Chase Manhattan Corp. said in an address before the New York Cash Exchange recently: "Our lawmakers have been more interested in checking the power of the private sector than harnessing it."

You can't beat on the nation's lenders and expect them to say, "Do it again."

So one can honestly wonder why banks are making even as many loans as they do in today's environment. And at least to this observer, those who want banks to expand lending activity are blaming the victim rather than the culprit. This won't solve the problem.

Mr. Nadler is a contributing editor of the American Banker and professor of finance at the Rutgers University Graduate School of Management.

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