Lend like retail banks: How commercial lenders can avoid balance sheet crises

By Martin McCann, CEO & Co-Founder

The failures of Silicon Valley Bank (SVB), Signature Bank and Credit Suisse earlier this year took the world by surprise. Though, we’re sure bankers were well aware that sea-changes in the economy required proactive changes in managing the balance sheet – which most are navigating quite well. 

In a nutshell, the recent crisis stemmed from SVB not properly managing its balance sheet in an environment of rapidly rising interest rates. It’s an interesting problem, because an increase in interest rates presents an opportunity to increase financial performance – but only if you have an appropriate split between customer assets and those other assets that provide structure to the balance sheet. 

SVB may have been an extreme outlier because they parked the bulk of their assets in low yielding long-term fixed income instruments. But in many commercial banks the asset side of the balance sheet is oriented toward longer-term fixed rate products. If you've got long term commitments on the asset side of the balance sheet, yet deposits paying floating/short-term interest rates that are being repriced, then in a rising interest rate environment the return on your fixed income assets will not cover the cost of the liabilities, putting you in a tough spot! 

With the banking situation now stabilised (we hope) the question is how to avoid future, similar incidents. From where we sit, as technologists on a mission to help commercial lenders modernize trade finance and working capital offerings, there are two things that stand out: 

Commercial banks need to diversify their lending portfolios and must invest in technology in order to do so.

The retail side of banks are generally better at this on both fronts. They do a lot of mass market consumer lending. Other than mortgages, lending to this sector is generally short-term in nature with a greater propensity for repricing when market rates change. That diversified lending portfolio gives them a lot of flexibility to respond to interest rate changes. 

Retail banking has also been far better at deploying technology that puts access and control into the hands of the customer, and using data (generally spending patterns, incomes etc.) to inform decision-making. In essence, they’re bringing payables and receivables behaviours to inform them as to whether to lend, how much to lend and what product to use. This is where the commercial banking teams need to get to. 

But, corporate finance is harder to underwrite - until now

Lending to corporate customers has generally been longer-term in nature due to the cost and complexity of managing revolving facilities. These products are more complicated and customised, which makes them harder to underwrite and maintain. What makes it even harder – unnecessarily so – is that there's been so little innovation for decades. 

Technology spend in the last 10 years in commercial banking, especially in the SME lending market, has largely been to address KYC and AML compliance related issues. As a result, most of the work in commercial lending is still manual. 

If banks had an appropriate proportion of their balance sheet in short-term loans, that could be created and managed in near real time, then the chance of experiencing excessive interest rate risk and mismatches as the macroeconomic conditions change would be much less. One way to better balance maturity mismatches and reduce interest rate risks on a bank balance sheet is through more working capital finance. 

The demand is there. One likely outcome of the banking crisis is that credit is going to get tighter. There are plenty of solid businesses out there that are going to be under pressure. We’ve already got a $10T working capital gap between what businesses need and the amount that lenders make available. There is, therefore, a tremendous opportunity for banks that wish to drive technology and data usage to make more informed decisions about short-term working capital loans to not only serve their customers better, but to also enhance their market share.

The biggest barriers are not credit worthiness or segment profit potential. 

We have the data and the technology today for working capital facilities to be correctly assessed very quickly and managed in real time, increasing lenders’ capacity many times over. The biggest barriers are change constraints, and outdated thinking. 

Working capital finance is not a dark art

Complex working Capital products, like Receivables Finance (RF), seems to have this mystical status in many banks, a reputation that it’s half risk management, half dark art. For example, more than half of all RF applications globally are abandoned by the customer or are ultimately declined by the potential lender, often after weeks of manually collecting data and shuffling paper around between customer and lender, and between different departments at the bank. 

But there’s no mystery here. It’s simply that the processes are inherently manual; and rely on systems, products, risk models and data sets that pre-date the internet.

Through the use of APIs, Trade Ledger is already working with commercial banks, such as HSBC, to cut the application to decision time for new receivables finance customers to two days. Once a customer has been onboarded, all they have to do is upload an invoice to the portal and they get the cash in 48 hours or so. This is the kind of lending that commercial banks need more of on their balance sheet: secured short-term lending, all done using real time data.

This year, we’ll also be delivering solutions for Large Corporate RF, and expanding our platform capabilities to include in-life credit management - including collateral management.

What typically happens with in-life management for all facilities, including for a receivables finance facility, is an annual account review to re-assess the facility. This is cumbersome and requires a lot of manual work, which is why it doesn't get done as often as it should; so many banks don't have a good enough understanding of where the risk in their portfolio lies. 

Any review has also traditionally used historic data, so the analysis is flawed from the outset as it is an outdated assessment of the health of the borrowing customer. We recently heard of one example where an RF facility was set up for a trucking company. When the auditors went to look at it four years later, the trucking business had failed and the operators had moved into a new business converting trucking containers into homes. 

No more manual position updates

With a digital RF platform, you don't have to rely on staff to update the position of all the companies in the portfolio. Nor will it call on outdated information such as an annual financial statement of accounts. The bank will have the visibility to monitor the portfolio at will, and have updates sent proactively. With real-time API connections into customers’ accounting data, lenders can spot new opportunities as they arise, allowing them to grow their book of business - and with an enhanced risk profile - while better meeting a businesses working capital and liquidity needs.

Commercial banks should be pursuing these kinds of modernisation opportunities across their lending portfolio to avoid a future scenario where a downturn in the market leaves them backed up against a wall, racing to evaluate their risk positions. Unfortunately, this is the kind of tech investment banks might put on hold due to the current uncertain economic environment. “If it's not earning money this year, then it's out” is what we are hearing regarding investment considerations in banks. 

Downturn or opportunity?

This downturn is bad, but like previous downturns, it will pass. And, like previous downturns, it will change the competitive landscape. That’s why it’s short sighted for banks to be cutting investment in multiyear technology innovations. These are precisely the innovations that are going to allow them to emerge safer, more profitable and more secure.

Commercial lending is a brutal business, and can be a drag on the performance of banks in difficult economic periods as loan losses and rollovers take their toll. The financial returns are often lower when measuring the commercial banking activities vs. that of the retail business in a bank. New technology offers an opportunity to close that gap and grow.

Our view is that in any great period of turmoil or uncertain market conditions, great companies are built. The banks who invest through the cycle strategically at the appropriate levels are often the only ones standing whenever the market turns up again. Which it will. The only questions are when, and which banks will be tech-ready to take advantage of the upturn.

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