American companies seeking to get loans from banks to expand their businesses are unable to access them due to the reluctance of banks to lend. This is because the banks have not yet fully recovered from the losses they incurred from the sub-prime mortgage crisis. The industrial and commercial loans that these companies used to get from the banks either as capital or to expand their businesses are no longer easily accessible. This discussion explores the current lending practices of the American banks and their impact on the companies that heavily rely on these credit facilities to run their operations.
Lending practices of American banks
Banks are very cautious about lending money due to the losses they incurred through sub-prime mortgage loans (Goodman par 24). The banks incurred huge losses and some are yet to get back on their feet. This crisis started when the real estate business started to thrive because of the increased value of housing facilities. Banks decided to take advantage of the booming real estate business and invest by giving sub-prime loans to citizens who could not afford the prime mortgages. The banks lowered their lending rates so that low income citizens could afford to apply for mortgages. They used the increasing value of housing as a justification for taking this risk because if the house owners were unable to pay their debts, the banks would repossess the housing facilities, whose value would have greatly increased. Unfortunately, the housing value started to decline and the low income citizens who had applied for the loans were incapable of paying their debts to the banks. The banks, therefore, were forced to reduce the value of the housing facilities. As a result, the banks incurred billions of dollars in losses. Many banks were closed down, but the ones that survived are still grappling with the impact of the crisis. The banks have, therefore, reduced their lending as a precautionary measure to avoid the reoccurrence of such a crisis.
All the credit facilities available to businesses from banks have dropped considerably, and this has affected many companies. Failure by banks to give loans has increased the impact of the economic crisis and citizens are cutting down on their spending because of the increasing fuel prices, job scarcity and huge debts. The value of housing is also decreasing. Denying businesses access to credit facilities can not improve the economy. As a matter of fact, it will lead to its continued deterioration because the companies require the capital in order to grow, expand and hire more employees. Companies that heavily depend on loans from banks have no other alternative but to postpone or terminate their development plans (Goodman par 5). If credit facilities were available, such development plans would be implemented immediately and this would lead to a speedy economic recovery. Withholding credit facilities is slowing down economic growth as corporations’ borrowing costs and rates of mortgage continue to increase.
The banks are now more careful when lending money since they learnt their lessons from the losses incurred due to excessive sub-prime mortgage lending. They are no longer willing to take high risks. Before the crisis, banks used to lend without carrying out a proper risk assessment to find out whether the customers had the capability to pay back the debts. They were also not keen on whether the borrowers were employed or not, provided they had some money in the account. This led to the banks investing a lot of money on low income house owners whose probability of paying back was very low. The banks found themselves in trouble when the value of houses plummeted and the mortgage rates increased, making it hard for the sub-prime borrowers to settle their debts. However, the financial crisis has compelled banks to be more cautious in their lending. They analyses the income and the ability of the borrowers to pay back in order to avoid losses. The banks have set new standards for qualifications for the loans. The companies that do not meet these standards are unable to access credit facilities. The bank executives have cut down on their lending to those industries that are not doing very well in these hard economic times. Those that are still thriving can access loans from the banks but they get them at higher rates and wait for longer periods before getting them. Companies are also taking precautions and are reluctant to offer their services on credit in order to reduce the risk of making losses (Goodman par 11).
The banks are reluctant to lend, even to companies that are doing well. The banks are looking at various factors including the organizations’ past financial performance as a basis to decide whether to give out loans or not. For instance, Global Harness is a company that is currently doing well and increasing its profits every year. However, the company is experiencing difficulties in accessing loans since the banks are considering that it made losses in 2005. The company, therefore, has to operate within the available capital since expansion plans can not be implemented as credit facilities are not available (Goodman par 27). Companies that are experiencing the greatest difficulties in accessing the loans are the smaller ones and those that have not been in operation for a long time. This is not helping the growth of the economy since the small businesses need to borrow so that they can expand and consequently, create more job opportunities for the citizens (Goodman par 27).
Business owners who used to have easy access to loans in the past are now shocked by the response they get when they try to ask for those facilities. The banks are letting them down at the time when these companies need them the most to expand their operations and acquire more equipment. Lack of credit facilities is causing serious negative repercussions to the growth of the businesses as they are forced to reduce some of their clients’ orders since they do not have access to enough capital to handle them. Lack of access to credit facilities is one of the biggest challenges facing companies today. This is because most businesses depend on loans to pay for their raw materials, labor and production costs since they are paid after producing their products and shipping them to the customers (Goodman par 18). Therefore, these companies have no money to finance their operations and are forced to seek funds through credit card accounts, which charge exorbitant interest rates. These credit card accounts are putting a huge financial strain on businesses.
The action by the federal government to pay interest on reserves has also led to the reluctance of banks to lend their money. This is because the action has hindered inter-bank lending. Lack of access to lending between banks has compelled banks to stop lending to businesses. Access to inter-bank lending enables banks to cover their liquidity against any deficits. This is because when that happens, they can borrow from other banks that have reserves in excess. However, lack of access to inter-bank lending leaves banks in uncertainty and this makes them reluctant to lend to other businesses. Inter-bank lending should be accessible in order to enable the banks to start offering credit facilities to the businesses. Most businesses can not flourish without credit facilities and economic recovery is dependent on thriving businesses.
It is evident from this discussion that there is reduced lending by banks to companies due to the unwillingness to take high risks. Businesses are now faced with a big challenge of getting funds for the working capital and to expand their operations. Most lending institutions have not yet recovered from the impact of the financial crisis and are, therefore, not willing to lend. The banks are also not willing to take high risks because they do not want to make losses as they did when they lent out a lot of money in sub-prime mortgages. However, failure of the banks to lend money to businesses is making the economy to deteriorate even further because these companies depend on the loans to expand their businesses and create more employment opportunities. To ensure quick recovery of the economy credit facilities must be availed to businesses. Banks should, therefore, use proper assessment procedures when issuing loans in order to stop denying credit facilities to deserving businesses.
Goodman, Peter. “Worried Banks Sharply Reduce Business Loans”. New York Times. 2008. Print