Should banks focus on relationship or transaction lending'
September 23, 2006
Should banks focus on relationship or transaction lending'. Check it out:(The Nation (Thailand) Via Thomson Dialog NewsEdge) Each country's banking system varies in the degree or weight of importance it places on the risk and closeness-to-client factors
Banks are like any other businesses in that they want to develop good and long-term relationships with their clients. Banks' terms of lending then may be driven by the desire to foster client-bank relationships while exploring other business opportunities, such as earning fee-based income.
Therefore, the importance of relationship factors should not be overlooked, as they provide inside information and future economic benefits to the banks. It is interesting to see how such factors are considered concurrently with risk factors in banks' lending decisions.
Banking practices can be grouped into two types. The first is transaction-based banking, commonly practised in the United States and the United Kingdom; the second is relationship-based banking, widely practised in Germany and Japan. Transaction-based banking treats each loan transaction as a single deal and focuses on the risk of the loan. Relationship-based banking involves investment and considers relationship factors to be valuable information and opportunities that are generated through the course of relationship building.
In the past two decades, American banks have shifted to transaction-based banking practices, in which price and convenience rather than the financial relationship are a means of attracting a steady stream of business. In contrast, German banks spend most of their time building up their capacities for pursuing relationship-based banking. Credit volume is not an explicit measure of performance, and price and convenience remain only a minor part of competitive strategies. German banks have stayed with a more conservative approach of growth through an existing and stable customer base.
In commercial lending, German banks develop close and long-term ties with small and medium-sized enterprises. Bank-firm relationships in the US, in contrast, have become distant and short-term in nature.
In the US, most large commercial banks treat small business customers essentially the same as their private retail customers. Few banks assign relationship managers to these firms to help them manage their financial business. Evaluation of loan applications, just like evaluations of credit cards, has become a centralised, back-office affair carried out by officers with no contact with business owners and little knowledge of a borrower's industry.
In the middle market, American banks are rather keen to avoid risk and to earn what they can from short-term business deals instead of cultivating truly long-term business relations. Relationship managers spend more of their time trying to find new clients than they do cultivating existing clients. Credit decision-making also shows a bias towards generating revenues from short-term business deals rather than from long-term financial relationships.
For most banks, the decision to grant a loan is based most heavily on a firm's balance sheet, the available collateral and an industry risk evaluation, while factors like a firm's management and the strength of its business plan are considered last.
In Germany, banks spend much of their time attempting to improve their capacity for relationship-based banking with small business clients. For most German banks, branch managers act as relationship managers for small business customers. These branch managers typically advise each small business customer on both private financial affairs and whatever financial questions that may arise in connection with the business enterprise. Credit-scoring programmes to assist the relationship manager in assessing risk are common, but personal impressions gathered through the course of contact is more important in arriving at a credit decision.
German banks typically play a key role in helping medium-sized companies overcome financial or business crises by drawing on the expertise gathered through experience with other firms. Financial information is used as a guide to credit decision-making but is outweighed in importance by factors related to a firm's management, organisational strengths and proposed business plan.
However, it is generally neither possible nor practical to describe a banking system as being based purely on transactions or purely on relationships. Conventional wisdom says it may not be optimal for banks to consider only risk factors and not relationship factors or vice versa, because both can reveal important information.
In practice, most banks in many countries consider risk and relationship factors alike, because both types are valuable in their loan-making decisions. It should not be surprising (or regarded as inappropriate) to find that banks in many countries, even in developing nations, consider both types of factors in their lending decisions.
Therefore, it is expected that each country's banking system may vary in the degree or weight of importance it puts on risk and relationship factors.
The writer is director of the Financial Policy Section of the Finance Ministry's Fiscal Policy office. He can be contacted at [email protected].
Chodechai Suwanaporn
Copyright 2006 The Nation Publications (PVT) Ltd. Source: Financial Times Information Limited.
Related Tags: based banking, relationship factors, german banks, relationship based, transaction based, banks
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