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How do Banks Exert Control and Influence on Business Loan and Working Capital Facilities ?

Guest post by: Stan Prokop

Article Overview: The articles provide insights as to criteria used by banks to exert influence and control on business commercial borrowings.

How do Banks Exert Control and Influence on Business Loan and Working Capital Facilities ?

Most business owners and financial managers aren't necessarily aware of the methods and factors that banks utilize to control and monitor their loan facilities with commercial customers. We are talking about two types of loans essentially, term loans, and also operating lines of credit, also called ' revolvers ' by some . (Revolver - the credit line revolves, it goes up and down on a daily basis ...)

Banks essentially use several different strategies to ensure they have maximum control and influence on the business borrower.

Banks often are reluctant to allow maximized borrowing from other parties for asset growth. Why? This is because when a customer has to service the additional non- bank debt they might be unable to service the banks loans. Banks have very well known and published cash flow ration and they want to ensure their customers can meet these rations on the bank debt. Naturally if a bank feels comfortable with a customer growth and cash flow profits they are much more likely to approve a third party financing . If they aren't comfortable they may ask the company to at lease temporarily defer bonuses, dividends, or, in the case of a public company, a stock repurchase.

Bankers of course usually know the company very well, as a relationship and financial history has developed over the years. They will often want to have input into the company's growth direction in an effort to ensure the customer is not going down a path that in their opinion, might lead to liquidity loss or profitability loss. This sort of 'advice' from a bank can come in a number of manners, one of which is simply providing a debt to equity ratio that cannot be overlooked by the customer.

Business owners know that it is no ones best interest for the bank to trigger a default on a loan - it's clearly a case where both parties have a lot to lose. However if a bank feels on a number of fronts that the customer is spiraling downward they will take steps to ensure their loans are provided for.

What are some of those downward spiraling scenarios? They include:

Cash flow deterioration

Asset erosion

Working capital problems

Again, the worst case scenario is the bank 'calling the loan '. We have agreed this benefits no one, so the bank usually prefers (as does the customer!) to return to the bargaining table. At this time business owners are strongly cautioned to prepare a corrective action scenario to satisfy the bank. It is at this time that the bank normally considers an interest rate increase, or more restrictive covenants.

We also want to point out to business owners that banks want to ensure that there is a proper ' matching ' of financing . By that we mean that the bank does not want the customer to borrow short term to finance long term scenarios. For this reason working capital ratios are put into place.

Finally banks utilize whets known as a 'negative pledge 'clause. This forces the company to consult the bank when pledging other assets or selling unencumbered assets. If such sales are agreed to the proceeds are usually used pay down the bank.

In summary, it benefits business owners to understand the whys and wherefores of bank strategy and influence and control around business loan scenarios. Understand where the bank is coming from allows a business owner to more proactively plan financing growth with a view towards successful financing.

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Article Tags: bank loans, bank restrictions, covenants



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