There’s been a lot of discussion over the last year or more in the media about the state of lending. The popular view has been that it’s costing too much for firms to borrow and/or that it’s too hard to get loans – usually followed by a conclusion that this is holding back the recovery.
The general response from the banks has been that they stand ready to lend but there’s no demand. If the cost of loans has spread, that’s a better pricing – not a mispricing – of risk following conditions that were far too loose before the financial crisis, so the banks say.
There’s certainly a lot that can be written and said in this debate but there’s also a lot that doesn’t get much attention. Take cost – where the media focus is on what’s happening to the Bank rate, how that’s being passed through onto rates on loans, and changes in the spreads between different types of loans (or customers). As every business knows however, there’s more to the cost of lending than the headline interest rates.
Anecdotally we’ve been hearing a lot about how some of the other costs around loans may have changed following the financial crisis.
There are many costs associated with loan origination – the process from the setting up of a loan to its disbursal by the financial institution. These can include due diligence costs assessing a firm’s business plan, requiring a firm to take out credit insurance, or the valuation methodology used on security.
How might these have changed?
For due diligence a bank might only be prepared to accept the analysis of an accountant or a lawyer that it approves. Why? Because the bank may want some reassurance that this analysis is going to be robust so it wants it done by someone it trusts. This might mean a higher cost for firms if the banks’ preferred professionals are more expensive – or, worse, if the firm has already paid for such analysis and then has to pay for it again.
Credit insurance might now be needed if a business plan involves selling into a market with long lags between delivery and payment, particularly export markets. This might be a new cost firms haven’t faced before if banks are feeling more cautious about how reliable creditors are.
Valuation methodology might impact on credit availability and price. Banks may now be more cautious about the value they put on a firm’s collateral. That means less lending for a given amount of collateral – a reduction in availability. Alternatively, faced with a lower collateral value, banks may demand a higher rate on their lending – a higher price.
I’m not saying necessarily that these changes have definitely happened or, if they have, that they aren’t warranted. But there are two things that occur to me when some of these other costs of lending are included in the overall picture of lending conditions.
Firstly, how does the increase in spreads square with an increase/tightening in these other conditions? Is this banks taking two bites of the ‘better management of risk’ apple or are they managing different risks in different ways?
Secondly, how visible are these other costs for a business customer trying to decide which bank to ask for a loan? If they are visible how uniform are the costs between different institutions in our (not very) competitive business banking environment?
It seems to me that a possible answer could be that at least some of these costs are somewhat ‘below the radar’. Further, if they were a little more widely known about could these costs perhaps be better exploited as an avenue of competition to lower costs for firms and improve the lending environment?