The banking industry is being painted as the scapegoat for the growing economic malaise that now infects the nation.
In particular, criticism of commercial banks for failing to lend money speedily to needy borrowers is reaching a fever pitch. This failure to lend is becoming viewed as un-American by people who know little if anything about commercial banking.
A bank's propensity to lend is a function of the loan opportunities it is offered when it has the ability and desire to lend. Sound bank management dictates that the ability to lend is dependent on stable deposits and adequate capital.
The ability to lend is a necessary condition, but it alone is not sufficient to encourage loans.
This ability must be combined with a bank's desire to make loans. That desire, in turn, is dependent on numerous factors that affect bank management.
Too often today's bank critics say that commercial banks are driven entirely by the profit motive, and that they fail to appreciate the roles played by other factors. These observers believe that if you give banks money, they will lend it. Such a belief reflects a sophomoric understanding of the fundamental principles of lending.
An examination of the five "C's" of lending (character, capacity, collateral, conditions, and capital) shows that each is weakening and threatening commercial bank loan portfolios. The observable weaknesses in consumer and business spending are rooted in real fear regarding the immediate future.
Already we have seen the character of borrowers tested by declining home values. Increasingly, those borrowers have elected to walk away from their obligations. The stigma once associated with a failure to repay debt is quickly evaporating. It has been said that in making a loan, nothing is more important than the borrower's character. Nothing tests character as much as a decline in the value of collateral to the point that the loan balance exceeds it.
The capacity of a borrower to repay is dependent on free cash flow. For most individuals, their employment provides that source of funds. Businesses get their free cash flow from sales and the collection of receivables. Unfortunately, more individuals are being laid off, while businesses are seeing sales deteriorate and receivable collections slow.
Lenders nationwide are about to experience an amazingly rapid rise in delinquencies as cash flows of individuals and businesses disappear.
The equity capital of businesses is bound to decline as business conditions fade in the coming months and their losses mount. Consumers account for about 70% of the economy, and their wealth has been decimated. An estimated $4 trillion of consumers' net worth has been lost from home values during the past two years. Additionally, in the past 12 months alone the value of stocks traded on the New York, American, and Nasdaq exchanges has plummeted by $6.5 trillion.
It should come as no surprise that this month consumer confidence reached its lowest level since at least 1967. The negative wealth effect caused by the loss of $10.5 trillion in the net worth of consumers from stocks and real estate, a generalized loss of confidence, and looming layoffs combine to make the absolute worst lending conditions in a generation.
Community bankers need to ignore, as best they can, the unflattering portrait being painted of them. Instead, they need to do whatever is necessary to shore up the loans already on their balance sheets, while continuing to meet the legitimate needs of their communities.
They need to get prepared for the ricocheting economic bullets that are heading their way and are bound to cause borrowers to go belly-up everywhere in the nation.
Most of all, community bankers need to realize that they are not immunized from this economic calamity, and that their chance of being bailed out by the federal government is remote.
