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- Understanding Banking Relationships
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Understanding Banking Relationships
A significant factor in determining the creditworthiness of a business is gathering information about your customer's business relationship with its bank. Understanding when and how to obtain information from the new or existing customer’s bank can provide the credit professional with a more complete understanding of the risk associated with offering that customer or applicant open account terms.
How Banks Lend Money: There are basically two ways a bank lends money: unsecured loans and secured loans. An unsecured loan relies only upon the customer’s promise to pay. Consequently, this form of loan is rare. Thus, it should not come as a surprise that most loans issued by banks are secured loans. This means that the bank is likely to have recorded some form of security interest in asset(s) of the borrower. This should not be considered as a negative since secured loans are the norm and unsecured loans are the exception.
A loan granted on a secured basis is generally backed the pledge of collateral such as marketable securities or other assets of the company. When a personal guarantee is given, the financial strength of the individuals backing the notes determines its collectability. When collateral is given, the lender usually looks in whole or in part to liquidation value of the pledged property in the event that the loan is not regularly paid.
A credit professional may come across an account that is considered a prime credit risk, eligible for an unsecured loan, but borrowing on a secured basis. To properly evaluate the credit risk, the executive should discuss the account with the bank to determine the quality of the loan and collateral. It may be that the customer requested such an arrangement in order to obtain a lower interest rate.
Edited by Michael C. Dennis. Mr. Dennis is a consultant and author. He can be reached by e-mail at mcdennis13@yahoo.com