We know that financial institutions are tightening their credit standards for lending. But we don’t necessarily know exactly how financial institutions are addressing portfolio risk management — how they are going about tightening those standards.
As a commercial lender, when the economy was performing well, I found it much easier to get a loan request approved even if it did not meet typical standards. I just needed to provide an explanation as to why a company’s financial performance was sub-par and what changes the company had made to address that performance — and my deal was approved.
When the economy started to decline, standards were suddenly elevated and it became much more difficult to get deals approved. For example, in good times, credits with a 1.1:1 debt service coverage could be approved; when times got tough – and that 1.1:1 was no longer acceptable – the coverage had to be 1.25:1 or higher.
Let’s consider this logic. When times are good, we loosen our standards and allow poorer performing businesses’ loan requests to be approved…and when times are bad we require our clients perform at much higher standards. Does this make sense? Obviously not. The reality is that when the economy is performing well, we should hold our borrowers to higher standards. When times are worse, more leniency in standards may be appropriate, keeping in mind, of course, appropriate risk management measures.
As we tighten our credit belts, let’s not choke out our potentially good customers. In the same respect, once times are good, let’s not get so loose regarding our standards that we let in weak credits that we know will be a problem when the economy goes south.