A bright future for good loan officers

Following the publication of his book, ?A Blueprint For Better Banking?, Niels Kroner comments on banks? approach to lending:

Over the past year, the media has been full of terrible news about the availability of credit to most companies, especially SMEs. Many lenders, even relatively healthy ones, seemed to have tightened credit standards considerably.

This has often made life, already difficult in a weak economy, even more challenging for many companies. On this background, it is illuminating to look at the lending practices of Svenska Handelsbanken (also familiar to readers of the news because they just topped customer satisfaction polls.)

The common approach to lending is illustrated by the first graph which shows lending to corporate customers in the Eurozone. Most banks influence their lending decisions top down depending on their views on the economy and their outlook for loan losses. This can reduce the influence of the loan officer handling an individual case. The loan officer might have performed a thorough quantitative and qualitative analysis of the prospective borrower. But in this system, a loan that would have been approved a year ago is now declined. This is illustrated by the chart: at the beginning, when the economy was still recovering from the dot com bubble, banks were still fairly strict in their lending standards. But as the economy started growing nicely and steadily from quarter to quarter (the blue line), lending standards (the green line) were relaxed more and more. The result: loans to corporate customers were growing faster and faster (the red line). The moment lenders see signs of a weakening economy, lending standards are reined in and loan volumes fall as a result. This approach seems rational only for five seconds because drastically cutting off lending exacerbates the economic contraction that lenders were afraid of in the first place. And this policy generally leaves banks with loans made on wafer thin margins in good times when quality can really only get worse, but they do not make loans on much better margins at the trough of the cycle when credit quality could arguably only get better.

Figure 1: Eurozone GDP growth (quarterly), lending to corporates and bank lending standards

Handelsbanken, by contrast, does not change its credit policy over time. It does not believe in GDP or other macro forecasts. It rather believes in sound credit analysis of an individual customer. Hence no need for the bank headquarters to tell the loan officer at the front line how to do his or her job. In addition, the bank believes in Warren Buffett?s insight that ?it?s only when the tide goes out that you know who is swimming naked?. In other words: during good times both good and bad credits look similar, but in tough conditions like today?s it is fairly easy to spot the good customers you want to continue lending to. Handelsbanken?s bankers have a much more satisfying and intelligent job where they can use their expertise and judgement to come up with their own best credit decision.
As a result of this policy, Handelsbanken?s lending to corporates is highly counter-cyclical. When everyone else is competing to lend, Handelsbanken?s market share drops, and when no loan is to be had from any other bank, Handelsbanken keeps lending happily and increases its market share again.

Does it work? By following this very simple and common sense approach, Handelsbanken has achieved a twin goal of having higher margins than their competitors AND loan losses that are consistently about 50% lower. The bank follows the same approach with the same results in other countries such as the UK. The loyalty to their customers even in bad times may be one of the reasons behind their stellar customer satisfaction.

Unsurprisingly, many other banks are looking at the Handelsbanken model today. Experienced loan officers should be in for a bright future.

Figure 2: Sweden, lending to corporates