Risky Business

It has been a month for the ages. The COVID-19 Pandemic has changed life as we know it, at least for now.

I am not sure how long this pandemic will last. It will pass, but when? A stimulus package is on the way – a package designed not just to provide immediate relief, but to move the economy back to pre-virus vitality. This, of course, will require the United States to turn on the economic switch, to open the markets up, and get people back to work. Again, the question is when?

Experts much smarter than I will determine when we can get back on our economic bike. But one thing I do know is that the banking industry will, and should, play an integral role in our country’s economic recovery. However, the industry and our various regulatory agencies are going to have to change their perception of, and appetite for, risk.

During The Great Recession (2007-20131), the banking industry went through enormous changes. Many of the changes were driven by the regulatory agencies’ collective quest to “fix” the banking system, which they perceived as an industry managed by bankers that were allowed to take too much risk with their balance sheets.  In a number of instances, the regulators were right to tighten up on the industry, and the results of their regulatory efforts bore much fruit.

For example, banks are much better underwriters of credit than they were prior to the days of The Great Recession. Take borrower global debt coverage calculations for example. Prior to The Great Recession, an accurate calculation of borrower global debt coverage ratios at banks was somewhat hit or miss, if done at all. Now, global debt coverage calculations are standard fare and even the smallest banks are adept at this calculation.

So, much good came out of regulatory agenda emanating from The Great Recession. But there were negatives, the biggest of which is that most of the post-recession regulations benefited the large, national banks at the expense of small regional and community banks. Want proof? Just look at the concentration of banking assets and deposits across the United States. The concentration of assets and deposits amongst the large, national banks was greater after The Great Recession than before.

But a less obvious negative consequence of the regulatory effort post-recession was that the banking industry became too risk adverse. Bankers, wanting to keep the regulators at bay, began to think more like regulators than banking professionals.  This resulted in a pervasive, and somewhat unrealistic, attitude throughout the banking industry that risk needed to be squeezed out of every loan transaction. Unfortunately, this attitude toward risk will need to soften or the industry and, for that matter the country, will have a hard time recovering from the COVID-19 Pandemic.

Don’t get me wrong. I am not advocating a return to sloppy banking practices. At Artisan Advisors, we are all about practical, thoughtful solutions that are regulatory compliant, as anyone we have worked with knows well. But what I am advocating is that banks, and the regulatory agencies, are going to have to be more creative in assessing and granting credit as a result of COVID-19.

How so? Historical cash flow analysis is one example. Over the next 6-12 months, some borrowers’ cash flow numbers are going to look awful, which will negatively affect debt service calculations, and quite possibly mean that many previously creditworthy borrowers will not be underwritten for approval. So, bankers are going to have to place much more emphasis on projections than has taken place since The Great Recession. That means bankers are going to have to dig deeper into their customers’ strategic plans and better understand the assumptions around their projections. Lenders are going to have to be more businessperson that banker. In short, the bankers are going to have to accept more risk.

The regulators are going to have to accept more risk, too. The agencies need to understand the world has changed and that the evaluation of credit is no longer purely based on historical, mechanical analysis. As with the bankers, the regulators will need to take a more business-friendly approach to their evaluation of credit during their upcoming exams versus the traditional approach taken since The Great Recession; in many cases that has been completely reliant on historical performance. Regulators should not blindly agree with a set of projections on file.  But if the projections are well thought-out and understood by the banker, the regulators need to give the banker, and ultimately the borrower, the benefit of the doubt.

Post COVID-19 Pandemic, “getting back to normal” is going to take a lot of time and effort. We will all have to do our part. The banking industry’s role in our economic recovery is to provide capital to our country’s businesses and let our business community do what its always done: provide the best, most innovative products and services in the world. The banking regulators need to have a role in our country’s resurgence, too.  Not as a hindrance to the flow of credit, but as practical regulatory overseers with an eye towards helping make the recovery we all want – and need – a reality.

  1. com editors, Aug.21, 2018, https://www.history.com/topics/21st-century/great-recession-timeline


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