Community Banks are closing their doors because of the cost of compliance. Small Business pays with less access to credit. Unintended consequence of one size fits all regulation schemes.
WSJ Headline “Tally of US Banks Sinks to Record Low” on December 3, 2013. There were many banks that failed as a result of the financial crisis, but-the real impact of the reduction of banks in the US is on small businesses that rely on credit from Community Banks. This means less credit for small businesses who rely on the Community Banking network for working capital and lines of credit
Community Banks are bearing the brunt of Dodd Frank because of the costs of compliance with the new regulations and are closing as a result. The new regulations are being enforced through out the banking system even though throughout the financial crisis Community Banks were not the cause of the crisis or nor even a significant portion of the crisis could be attributed to Community Banks.
Community Banks are smaller banks with several hundred million dollars in assets that are typically formed by successful local businessmen and women. Their typical business plan is to stimulate the local economy by lending to other small businesses that large banks tend to avoid. These smaller businesses require more support than a typical money center or regional bank is able to provide. However, their presence in small markets and even in major metropolitan areas such as New York City is vital to the strength of small business and their ability to grow. They provide accounts receivable lines of credit, equipment loans, real estate loans and in some cases even accounts receivable factoring.
Community bankers work on the principal of the Three C’s: Credit, Collateral and Character. Large banks work off of computer models that determine whether or not you will be granted a credit line. In most cases cyclical business, which many small businesses are characterized as, do not stand a chance against the money center or regional bank’s computer models as they are regularly rejected. The beauty of a Community Bank pre Dodd Frank was that the small business owner could sit down with their local community banker to review the collateral, demonstrate they have good credit and character and establish a credit facility to help grow their business. In the alternative, if there was not a chance that the bank could lend to a small business they would let them know immediately. There is a benefit to a fast “No”.
We see this time and time again in our business at Capstone Capital Group, LLC. Clients tell us they our factoring services as a backup to the line of credit they are applying for. We can see immediately that there is no chance they will be approved by the money center or regional bank’s computer model. However they go to the bank and apply through a business officer who is not trained to prequalify the applicant. Several weeks are wasted in preparing and presenting all sorts of information that is required as part of the application process. Once the loan request is denied, the business owner cannot make up for the lost time consumed by the lengthy application process that resulted in a denial of credit.
Most non-bank financial institutions that support small business act like the pre Dodd-Frank community banker in many ways. The Three C’s are employed because they take the time to understand the customer’s business and attempt to craft a program that will help the customer grow.
Speaking from experience, we were in need of a $10,000,000 letter of credit facility to support our trade finance business. We went to one of the large banks that you see on every corner in New York City where Capstone Capital Group, LLC has its operating accounts. We advised the bank that we did not want to borrow from them, but instead we wanted to give them money so our letters of credit were cash collateralized. You would think this is a pretty safe credit facility; after all we are giving them cash as collateral. Although we were using our own cash to collateralize the “credit facility” we still had to provide a significant amount of both business and personal information. This was understood since they are regulated by the federal government.
What we were not prepared for was the approval process. The bank actually wanted us to put up $20,000,000 for a $10,000,000 credit facility. The process would work in the following manner:
- A $10,000,000 deposit would be used to establish the letter of credit facility
- When letters of credit documents were presented we were not able to use the $10,000,000 that had already posted as collateral to pay for the goods purchased under the letter of credit.
- New funds would constantly be needed to provided the bank to cover the drawings under the various letters of credit issued so the $10,000,000 in collateral would always be on deposit.
We inquired as to the logic of this approach and we were advised that their system is completely automated and in fact there was no human intervention whatsoever. To ensure that they did not extend us credit without cash collateral we were required to have twice the value of the letter of credit facility available to the bank. Needless to say we took our business elsewhere where the credit terms made more sense.
The federal government wants small business to thrive and grow and hire new employees to reduce the unemployment rate. However, the federal government’s policies have unintended consequences that actually stymie progress for small businesses. Could you imagine the growth rates of small business in the U.S. if the regulations that restrict their growth and ability to borrow were relaxed? There would be one hell of an economic recovery underway!!Visit our website or connect with us on LinkedIn or respond below should you wish to discuss this further.