Why Banks Do What They Do

September 2022

Why Banks Do What They Do. (An entrepreneur’s guide to borrowing money.)

???___________________________

This is the first Business Lending Post in an ongoing series of articles that the Pasadena Private Lending Team will periodically author.?We hope small to mid-sized business founders and managers may benefit from our views on lending, credit and raising growth capital.

???____________________________

Objective: Help entrepreneurs better understand their local banker and the differences between traditional banks and the growing number of non-bank lenders. We will also review what the team here at Pasadena Private Lending does more differently still.

To begin, banks are neither “charities” nor “villains seeking to embarrass and destroy entrepreneurs’ self-confidence.” Banks do not intend to be pedantic or slow. But there are forces out of the control of bankers that make them cautious to the extent they leave prospective borrowers wondering, “why could a ‘yes’…or even a ‘no’ take so long?”

So why do banks do what they do the way they do it?

Banks warehouse depositors’ money until it can be lent out to those that really don’t need it. The vision of cold and calculating “Mr. Potter” from the movie “It’s a wonderful Life” comes to mind.?But, in fairness to that character and all bankers, recall that stock market investors have risks of taking losses but can also make potential fortunes. ?For bank lenders, at best they hope to receive their money back with little opportunity for any upside to cushion losses elsewhere in their loan portfolios. Yes, they charge interest, but their rates are only enough to cover capital and operating costs. That is, a bank’s profit margin (interest charged) is relatively low (especially on a real or inflation-adjusted basis). The possibility that regulators can totally shut them down completely for multiple incidents of imprudent lending adds to their possible downside.

Why are banks so constrained? Two words: regulators and lawyers.

For the good of the overall public, governments guarantee most bank deposits to limit systemic risks from “runs on banks.” The government therefore seeks to limit their blanket guarantee by writing and enforcing laws and regulations made by the Federal Deposit Insurance Corp and other Federal and State banking authorities which are interpreted by banking lawyers and bankruptcy courts. As there are so many banks, bank branches and bankers, laws and regulations are written to control even the most miniscule detail within typically widely decentralized credit granting process.

And, given the near failure of the system during the Global Financial Crises of 2007-2009, regulations have only gotten tighter.

How are non-bank lenders able to make loan that banks can’t or won’t?

For one thing, non-banks have far lower external regulations. They only need to meet their owners/investors return expectations. They balance accepting higher risks by having experienced lenders…often highly regarded ‘refugees from the stultifying bank regulatory environment.’ They use their experience to make loans that clearly don’t meet strict banking rules but they charge high interest rates and fees and costly equity “kickers” that allow them to take the occasional loss and still generate sufficient profits for their owners. And, by not having the complex regulations, they can move faster and be more candid about a prospective new loan’s acceptability. On the other hand, most non-banks tend to think of your loan as a stand alone transaction and not a long term relationship; they endeavor to maximize their returns on each loan they make. It is the resultant unsupported higher risk/higher return philosophy that makes them the so-called “lender of last resort” for most entrepreneurs. That is, they are typically both expensive, inflexible and highly reluctant to work with an entrepreneur experiencing even minor unexpected challenges.??

So, what does Pasadena Private Lending do differently?

In short, we are entrepreneurial, fast, flexible, priced fairly and reliable. That is, we are much like other non-banks lenders except we think about building long-term relationships. That means we are willing to consider unusual circumstances and unique structural requirements while we maintain focus to respond promptly and candidly.?How do we do that? We typically require a personal guarantee that can substantially reduce our risk and so your borrowing costs are lower and we can be more flexible to your needs. Yes, a so-called “PG” is a weighty concept; but, to entrepreneurs that believe in themselves, their business and their team, a PG is a way to reduce borrowing costs and “get the loan you want instead of the loan you can get.”

We look forward to answering your questions about your business borrowing needs. (Be sure to check us out at www.pasadenaprivatelending.com.)