Adapting to Changes in Banking and Banks
Change Management for Banks and Banking
Banking and banks have reflected significant changes during the past 25 years. First there was a savings and loan crisis in the 1980s that drastically altered the way banks operate. The next major banking change was marked by the 1999 repeal of the Glass-Steagall Act that had governed financial institutions since the Great Depression. Finally the financial crisis that emerged in early 2008 caused many banks to fail and has renewed the relevance of the term "Zombie Banks" for banking institutions having a negative net worth.
Many bank changes have been viewed as negative while only a few have been considered as positive. In either case, it is necessary to adapt to a rapidly-changing financial environment. Businesses, governments and other organizations routinely use a formal process called "change management" to help all parties cope more effectively with substantial changes. Without such an approach to help us with banking changes, it becomes important for individuals and businesses to adopt their own strategy for coping with a changed operating climate for banks. Real estate and small business financing are two of the areas that have been impacted most severely by banking changes.
Residential and Commercial Real Estate
Both commercial and residential real estate have been effected by changes in banking and banks. Without an adequate supply of mortgage financing, it is difficult for most potential real property buyers to proceed.
Because many of the real estate problems for banks were related to a faulty or inaccurate appraisal process, most lending institutions have revised their procedures for appraising properties. The appraisal changes have contributed to lower property values in most cases, particularly when foreclosed properties are required to be used as a comparable property by an appraiser. At the same time, many lenders have also changed the underwriting standards that borrowers must meet in order to get a mortgage loan. It is now more difficult for most borrowers to qualify for real estate financing than it was ten years ago.
During the past five to ten years, the employment market has generally been less robust and more unpredictable. Real estate is largely driven by supply and demand, and demand has been reduced by a volatile banking climate and uncertain business career employment environment. The net effect of these and many other changes in how banks make real estate loans has generally been a reduction in real estate values in many areas. This has caused a sizable downward drag on the entire economy because real estate and new construction represent a large part of total economic activity.
Small Business Financing
When banks were rescued by a bailout package in 2008, one of the primary reasons for doing so was to restore normal funding levels to small businesses. However, the legislation did not formally require this lending activity, and many lenders have instead allocated the money to other uses rather than commercial loans.
One of the small business areas impacted most severely by this relative lack of bank funding has been real estate construction financing. Working capital loans to small businesses have frequently been reduced or eliminated for even profitable companies. Commercial mortgages for refinancing have become harder to obtain.
To make financial matters even more challenging, it is often not clear whether a specific bank even has sufficient operating capital to make some loans. So-called "Zombie Banks" have more liabilities than assets, and these lenders are likely to reduce or effectively eliminate their mortgage financing activity. In most cases, the Zombie institutions either engaged in excessive real estate lending or risky derivatives trading (or both) in the period leading up to the financial crisis. When real property values suddenly declined, their liabilities exceeded their assets just as rapidly.
Should I Fire My Zombie Bank?
As noted above, avoiding Zombie Banks is a prudent goal. But what if your current banking relationships include one or more Zombie Banks?
- What if your bank keeps saying no?
- Is it just a negotiating ploy or does it mean something else?
In any case, another prudent business training goal is to have a Plan B for your bank financing needs.
Financial Strategies for Coping with Bank Changes
- Cash purchases instead of using debt for real estate purchases.
- Small businesses should reduce operating expenses and debt levels whenever possible.
- Find new sources for financing. The best source will not always be a bank.
- Small business solutions should usually include improved business negotiating and communication.
- Case-by-case strategies. Examine alternatives carefully.
Sheila Bair is the former head of the Federal Deposit Insurance Corporation (FDIC) and did her best to warn government officials about what she saw as a developing bank crisis. This was well before the actual banking meltdown began. They didn't listen to her then, but we can listen to her now.
Risk measurement for small business financing is an activity that commercial borrowers probably gave little or no thought to until most banks and other commercial lenders stopped making even routine business loans to small businesses throughout the United States. While most bankers have portrayed their dramatically reduced levels of working capital financing and commercial mortgages as something that should not be of real concern, the failure of banks to sustain anything remotely close to a normal amount of commercial financing should serve as a meaningful warning to all concerned. This article and others describe a number of commercial finance risks that should be measured by small business owners as a critical part of their financial decisions. The most practical and effective small business solutions currently include commercial bank consulting and business finance contingency planning.
A funding solution from banks is not routinely appearing for business finance needs that most owners currently have. Banks have been the traditional source of small business loans for several decades, but this role seems to be growing to a close. As a result, it has become essential for borrowers to both evaluate their commercial finance needs and find new sources for commercial financing and working capital loans.
But an earlier point deserves to be repeated — borrowing funds from banks should never be the only solution. For business borrowers in particular, reducing expenses and increasing sales revenues should be a priority before arranging a bank loan. Negotiating also has a special role in reducing costs of all kinds (and reducing risks).
A Sheila Bair Video
The banks should have been let go.— Sheila Bair
© 2012 Stephen Bush