An Entrepreneur's Guide to Understanding Bank Risk

The world has changed and entrepreneurs are having to take a hard look at their entire business to identify risks. Every entrepreneur will tell you that dealing with risk is as much a part of business as breathing, and sometimes it is the unseen risks that cause the most chaos. Wise entrepreneurs have a “Fab 5” or 5 advisors that push them towards success. Common members include their CPA, attorney, insurance agent, a more seasoned entrepreneur, and their banker. Each member of the Fab 5 brings a unique perspective and area of expertise. Many entrepreneurs rely on their banker to help them manage and fund growth, but the heart of a good commercial banker is in risk management. When a banker analyzes your business for a loan request, what they are really doing is looking at risk of your company and assessing the probability that the loan will be paid back, and if not, what is the probability that the bank will lose money. They look at all type of risk: cash flow risk, liquidity risk, leverage risk, management risk, supplier and customer concentration risk, reputation risk, and much more. Entrepreneurs deal with risk all time, so a good banker asks questions about each of these areas and should offer advise on how to protect yourself from the risk, but there is one risk that your banker probably has not asked you about.

What about your bank risk?

Of all the players in the PPP game, without a doubt the entrepreneur had the hardest position. I would argue that right behind them however, were the banks. The banking system was asked to administer a newly created program on a size, scope and scale like never seen before. While simultaneously dealing with the new normal of social distancing, remote working, and with a stacked deck (i.e. it does not take a PhD in economics to figure out that the $359 billion Phase 1 was not going to help everyone). I am extremely proud to be a banker, as I believe that bankers played a vital role in supporting millions of jobs. Those weeks from early April to mid-May saw many bankers catching a glimpse into what entrepreneurship is like (too much work and stress and too little family/ decompressing time). But as stressful and tiresome as we may be, we will NEVER have to look a 10-year employee in the eye and say “I’m sorry, we have no revenue, and I can’t afford to pay you”. It is this realization that has driven us to support you in an unprecedented and I think a noble way. I may be biased, but I believe that as an industry, bankers really stepped up and supported entrepreneurs in one of their darkest hours, in a way that was honorable and selfless. It was not without challenges, disappointments, and mis-steps, and I am sure that not everyone had a good experience (and for that I am truly sorry). But when you objectively look at the lemons we were given, it makes the lemonade a bit sweeter.

Now, having said that, I can also critically look at the past 2 months and talk about a risk that I may not have seen before. Banking Risk. As an entrepreneur, you often rely on suppliers to support your business; and if there is only a single provider of that supply – your business is exposed to a risk. You had better hope that that supplier doesn’t go bankrupt, have a fire, or have disruption from their supplier. Many entrepreneurs have only 1 supplier for their banking needs. Which poses the question, “What makes your banking relationship any different than your other suppliers?”

Now I can tell you all the answers that most bankers will give you, but the fact of the matter is that you have to do what is in the best interest of your company. Any banker that is not 100% supportive of that fact does not have your best interest first. Which may mean having more than 1 banking relationship.

Now, having said that, you also need to be aware of the impacts of a multi-bank relationship. So, as your insider to the banking industry, let me tell you what you need to know as you are developing a game plan to lower your banking risk.

Criteria for selecting a secondary bank. 

1. Financially secure. The financial crisis of 2008 demonstrated the need to have a banking partner that was financially strong and able to weather a down financial cycle. In the wake of 2008, the government mandated that all banks be periodically “stress tested”. Think of this as a financial audit to make sure that the banks had enough cash on hand to support their customers and absorb losses (primarily from loans going bad). You can look up these test results along with the corporate bond ratings for most banks.

2. Diversification of size. Banks range in size from single office organizations to global juggernauts. Based upon your needs, you may find that you are better served by one or the other; as each provide different offerings and value. I would recommend that if your primary bank is local or regional, then your secondary bank should be larger. If you need the capabilities of a larger bank for daily operations, then consider a smaller bank for your second relationship.

3. The banker is as important as the bank. It would seem logical that you maximize every relationship you have, so don’t settle for a secondary banker who is just an order taker. To find out more about what to look for in a banker, click HERE.

Products at the secondary bank

I recommend that you have both a deposit and lending relationship with your secondary bank. This will allow you and the bank to get to know each other in the 2 critical areas. This is a natural fit for entrepreneurs who follow the Profit First methodology; which encourages a secondary bank as a place to secure your profit and tax savings.

For the lending relationship, I would recommend a business credit card, or a very small line of credit (as not all bank have their own credit card platform). This also has the added potential benefit of not impacting your financial ratios. This is dependent upon your banks review rules, but many banks don’t dial in credit cards with a zero balance when determining debt service coverage and leverage. However, they do dial in a line of credit (even if it has a $0 balance) in these calculations, which is why you want to keep it very small.

Impact on your current bank

If you have any type of relationship with your banker, you owe it to them to be honest and upfront about the secondary banking relationship. While they may not like it, if they truly have your best interest first, they will be supportive; if not, well - that is telling.

Another thing to remember is that banks have to be profitable, just like every business. Banks make money through interest income (the income they charge for lending money) and on non-interest income (everything from service fees, credit card processing fees, treasury services, wealth management, etc.). Many times, a bank can price one service (a loan) very aggressively and make little or no money. However, this is offset by the other products and services that they provide (and charge for). So, if you decide to take business away from your primary bank, be aware that your relationship is less profitable than before. As a result, you may find that the rate on your loans may go up, or the rate on your deposit accounts go down. This is not the bank being petty, it is an adjustment to the profitability of the relationship. After all, you probably give price concessions to high volume customers. I would bet that you would eliminate those price concessions if they cut their orders by 80%.

Finally, you need to be sure that you don’t inadvertently violate a loan covenant. Sometimes, banks make it a requirement for you to maintain your primary deposit relationship with them (this goes back to the profitability item). You don’t want to do something that is supposed to lower your banking risk, but ends up having in a loan covenant violation. If you are not sure about this, then talk to your banker to get clarification.

I want to end with a note to my fellow bankers. While it may not feel comfortable to allow another banker into a relationship that you have fought hard for, especially after the April and May we just went through; but you are looking at this wrong. We MUST fight for the long-term success for our clients, and see the world through their eyes.

Being an entrepreneur is one of the most difficult and demanding things you can do. The good news is that entrepreneurship today is a team sport. Hit the connect button on LinkedIn or Facebook NOW and together we will work towards hitting your 10-year target. Along the way we will increase your profit, strengthen your leadership skills and transform your banking relationship into a strategic partnership. This will lead to confidence in your path, freedom to dream up bigger targets and a business that is enjoyable to own. When we connect, tell me about your PPP experience.

Greg Martin is an entrepreneur’s insider to the banking industry and passionately believes that every person was uniquely designed for a higher purpose and calling. Greg guides entrepreneurs in achieving their 10-year targets. His deepest passion is living life with his wife of 18 years and their wonderful son. Check out www.theentrepreneursbanker.com for more articles, videos, and podcasts.