Why Do Banks Want "A Relationship" If They Want To Reduce Concentration Risk?

Question

I recently read a piece by a popular author that observes real estate investors are gypsies when it comes to getting loans. They generally roam from lender to lender to get the best deal at the time for their situation and move on for the next deal.

This seems a bit counterproductive given that banks supposedly want to develop "a relationship" with their borrowers. I hear this time and again when I speak with small bankers. How can this be reconciled with the fact that the bank wants to reduce their concentration risk with a given borrower? How can this "relationship" persist given that it is at odds with the bank's own lending approach?

Thoughts? Ideas? Divine revelations? Is this just really code for the bank not wanting to compete?

Paul B. · Answer

Having been a middle-market commercial lender at what is now Bank of America, I can assure you that talk of wanting a "relationship" only means, "We want as much of your business as we can get, but only to the extent and for the amount of time that it suits us."

I've had to tell 20-year customers with impeccable credit and financials that their $10 million loan relationship had to be moved elsewhere by next year simply because they were in the wrong SIC code (that is, the bank was exiting lending to it, regardless of the numbers). The bank will spend a decade building that "relationship," and then they'll flush it -- instantly.

For the bank, a relationship means that we have it all...deposits, loans, credit cards, merchant services, your personal mortgage, your investment accounts (what we called "share of wallet")...the whole shootin' match, and while increased profitability is one reason, the other is nothing more than that they can mess something up and still be less likely to lose the customer. It's just too complicated to undo everything when they have you all sewn up.

I would never recommend that anyone give all of their business to one bank. You should always have another one in there, competing for business, keeping each other honest.

Also, be careful about where you keep your deposits. Having them at the same place you borrow can lead to surprises (see "offset" for more details).

J Scott · Answer

In my experience, banks want *serial* long-term relationships, not deep, concentrated ones.

In other words, let's do a couple loans today and when you pay those off, we'll do a couple more. Rinse and repeat...

That said, consistency goes a long way as well. After getting this serial relationship attitude from my current bank for over a year, they started to realize that all my 12-month loans were getting paid off in 3-6 months tops, and they recognized that they could probably lend more to me without much increased risk.

That said, despite the fact that I have an 800+ credit score, cash reserves and a great track record, asking the bank to up my line of credit is still like pulling teeth... :)

Vikram C. · Answer

There is also a difference between the local branch and the executives higher up. The local branch manager wants to develop relationships and increase branch deposits and profits. The executives higher up are more concerned about risk management.

Vikram C. · Answer

Bryan, I do not have a lot of relationships set up. I have a very good relationship with the people at my branch and they are willing to do small things for me that they would not normally in the general course of their business.

But the main thing for us business owners is sources of abundant and cheap funding, and that is not something my bank manager is able to pull off because his boss does not wish to do a working capital loan for my houses, which are like inventory to me. They want to do a full appraisal, etc. because that is what their lending guidelines require.

In short, I do have a relationship but the relationship is not as valuable as I would like it to be. Banks in India are very enterprising, by contrast, and it is quite a bit easier to explain a business to them and have them evaluate it with an entrepreneurial perspective. So I do find all this rules-based stuff a little frustrating.

Bryan Hancock · Answer

How are your local banking relationships going these days? Mine with Amplify in Austin is blossoming. I think the economy getting better is definitely helping with lending in my neck of the woods.

Vikram C. · Answer

I know my bank manager would love to do more business with me but his boss often comes in the way.

I also think that the relationship thing depends on how much. A bank may love to lend $5 million to one client but not $100 million. Each bank, depending on its risk management policies, will have its own comfort level with respect to how much to lend based on its capital levels. In addition, of course, the quality of collateral and LTV will determine some of this.

James Hiddle · Answer

They don't want a relationship with you just your money.

Account Closed · Answer

Vikram your comments are very interesting to me.

Another reason some banks (in the US) wish to develop relationships is that in my recent experience they are looking to become more friendly with clients they know can buy their paper and REOs. A banker would much rather call a client that is likely to know a deal when he sees it, he knows has money and can close, than to spin it out through a broker. Bankers are very commission adverse. If he has a rolodex of ppl he can call, there is no need to list on the MLS but can actually move it out of their books by the end of the week.

Vikram C. · Answer

I don't think it is a cultural thing - the U.S. is one of the most enterprising countries in the world. But I do notice that large companies in the U.S. seem to be a bit government-like in the way they function - very process-oriented and bureaucratic. The same processes that allow you to take a fairly stupid person and make him a reasonably effective manager also limits the potential of smarter and more enterprising employees. I think this could account for the difference between the banking cultures. (BTW, India has some horrible banks as well in addition to some very enterprising banks.)

One other reason for the difference in attitutes between bankers in the two countries is that banks in the U.S. are primarily focused on consumers - credit cards, home loans, etc. Banks in Asia have a much higher concentration of business and corporate clients, partly because the middle class there is much smaller. Those bankers cannot afford to ignore the business market whereas most banks in the U.S. can afford to do so.

Bryan Hancock · Answer

Do you have any idea why the Indian banks are more enterprising? The banks here seem to be massively addicted to groupthink as has been pointed out across many threads. Do you think it has something to do with being addicted to selling loans on the secondary market instead of being true bankers. Or is it related to how they are regulated? Is it a cultural thing?

The bankers I talk to seem to be more rational and bank-like when we discuss business outside of real estate. Real estate lines seem to be the equivalent of a four letter word right now. Why should that inventory be any different than financing heavy machinery or any other product. That collateral is much harder to move than real estate in the event of default.

I have asked for covenants and rational underwriting on lines and nobody seems to want to play ball. Small lines are easy, but who wants small lines spread across a number of lenders?! That is just plain stupid.

Why Do Banks Want "A Relationship" If They Want To Reduce Concentration Risk?

Why Do Banks Want "A Relationship" If They Want To Reduce Concentration Risk?

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