The Changes in Commercial Lending

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Table of Contents

Introduction
Commercial Lending Today and Ten Years Ago
Why Commercial Lending is more Risky Today
Conclusion
Works Cited

Introduction

Commercial lending refers to the practice of giving out money for loans to various known entities, which may include private businesses, limited companies, and partnership businesses. Some businesses undertake commercial lending to manage their costs of operation and capital needs. In some organizations, commercial lending calls for a bank loan extension, which also has a flat interest rate, time, and lending conditions. Commercial lending focuses on cash flows than collecting collaterals from the borrowers. The approach that commercial lending takes is to ensure that there is enough cash flow. The second focus is on collateral.

However, institutions’ major aim is not to ensure that they collect collaterals but to ensure that cash is continuously in circulation. Commercial lending is a practice that has majorly been embraced by institutions that have few physical assets in the form of assets. It is regulated by a complete evaluation of the borrower’s ability to repay the loan. The willingness of the lender to pay the loan is also considered before the loan is finally granted.

However, the practice of commercial lending today is much different relative to them how it was five years ago. The changes witnessed today have been influenced by the current economic recession facing most of the European countries and America. These changes have also been brought up by sharp declines in prices. Consequently, most of the banks have been negatively affected by the recession. Many of them have also faced lending problems. National banks or regional banks have bailed out some banks today. With this hint in mind, the paper focuses on comparing commercial lending today and 10 years ago. Besides, it will also discuss the increased risk of commercial lending in today’s market.

Commercial Lending Today and Ten Years Ago

The practice of commercial lending today has portrayed a remarkable difference relative to how it was done a decade ago. The current economic recession that has affected most of the banks in the world began in 2007. The recession has hit most nations in Europe apart from Australia. The downturn has also affected the United States of America. In all nations, the lending ability has also been crippled. Some banks can only be bailed out of the effects of the slump.

Cecchetti et al. reveal how economists have associated the current decline with commercial lending that happened in most of the banks (1). For a case in point, most of the institutions that went for commercial lending were aiming at investing in the housing industry in the United States of America. However, as the interest rates went up, borrowers were not able to repay their loans on time. Others were unable to repay the loans.

It is also worth noting that commercial lending ten years ago was majorly aimed at institutions that were not based on a huge asset stand. It also aimed at offering loans at lower interest rates compared to business credits. Institutions that took loans from commercial lending had the advantage of paying lower interests. The strategy is completely different from what is happening today. Interest rates in most of the banking institutions have gone up so much such that the principle of offering loans at lower interest rates has been bent.

Banks had to raise their interest charges to survive in the already competitive and flooded commercial lending markets. The value of the national currency in most of the nations today has also altered the trends in commercial lending. In most nations, the value of the currency has kept on fluctuating and decreasing in value. Interest rates have therefore been fluctuating. In most cases, they have turned to the upper side.

Ten years ago, the world economy was much more stable than it is today. The capacity of commercial institutions to carry out commercial lending today has decreased. In 2004, capital values were very low relative to the high capital standards today. Commercial lending is likely to deteriorate with an increase in capital values in the future unless the current economic situation is corrected. There has been a disorderly correction of the impacts of the economic recession affecting the world today. Every economy is struggling to correct the downturn without success. Most of the corrections are amiss. Hence, they do not give the intended results.

Consequently, the situation of most economies has deteriorated with time. Prices of goods have been going up every day with assets’ quality in most of the commercial lending institutions weakening over the years. Unlike what was happening ten years ago, there has been an increase in the expense of bad bank loans. This case has crippled the ability of most banks to do commercial lending. Most banks do not even have the cash to use to complete the loan circulation. Most banks have called for the international banks including World Bank to bail them out because of their inability to sustain their lending rates today. In the past, banks could control and regulate their lending rates. They could do commercial lending without any assistance from outside.

Commercial lenders today are aiming at weighing the value of various collaterals. The consideration is based on the quality, type, and equivalence of the collateral in cash in a bid to keep with the principle of commercial lending. Ten years ago, commercial lenders would always work with cash to fulfill the objective of ensuring cash flow in the organization. Such loans are offered at very high-interest rates. The borrower is supposed to trade off the speed of processing the loan with the high interest pegged on the loan.

In commercial lending today, loans are processed in as little as less than a day thus making commercial lending an attractive venture for those that require quick cash today. A decade ago, commercial loans would take several days to be processed. Lenders have eliminated the incubation period in today’s commercial lending. Another feature of the speedy process of loan processing is the variation in the interest rate. In several instances, commercial lending is pegged on the duration of processing. Waterhouse affirms the preference of commercial lenders is to offer loans that are repaid in a shorter period than loans with long periods of repayment (43).

Previously, most commercial lenders would have preferred borrowers who would take as long as 30 years to repay their loans. Most of the economies in the world had long-term targets. However, today, most lenders prefer a short period of loan repayment. Cecchetti et al. argue that borrowers of today pay more for quicker services (1). Banks will give rewards to borrowers who pay their loans in shorter periods than the initial loan period. This reward is given in the form of reducing interest rates. On the other hand, loan repayment delays or extension of the repayment period attracts a punishment.

Waterhouse concurs with this line of argument by revealing how commercial lending has become more flexible in today’s economic world than it was ten years ago due to better lending policies (43). Currently, the period of loan repayment has become very flexible. Consequently, the number of people going for profitable loans has increased. Commercial lenders are also using institutions to act as guarantors for individuals who wish to borrow money. Employees of various institutions can therefore take commercial loans and pay them slowly by having the commercial lenders deduct the repayments directly from their salaries.

A little share of an employee’s salary is deducted over a long period. Therefore, employees cannot feel the burden of loan repayment. Furthermore, they can carry on with life and meet the expenses. Such flexibility has made it possible for many people to take loans today. As a barrier, the time has been eliminated from the commercial lending process. In addition, loans are also being offered in phases, as the borrower may deem necessary.

According to Pacelle, with cash flowing in at intervals, borrowers can plan for various projects and acquire the cash only when they need it most (C1). This move has enabled them to reduce impulse buying and unplanned investments. Commercial borrowing has therefore become very helpful to most borrowers. In agreement with the argument Waterhouse reveals how borrowers were previously required to pay upfront fees by commercial lenders immediately their loans matured (43). By the year 2000, most of the commercial lenders would ask for a huge upfront fee to reduce their risk. Such poor policies have been eliminated in commercial lending today.

Another difference in commercial lending that was not witnessed as late as the year 2001 is the idea of credit unions taking part in commercial lending. In today’s commercial market, credit unions have been fully absorbed in the lending market. Most of the restrictions that barred credit unions from offering commercial lending services have been eliminated. According to Benford and Burrows, since most of the credit unions are public institutions, some minor restrictions are upheld to caution members from the risk of losing their total investments (48).

Being made of a union between various people, they can become very competitive in commercial lending. Such antagonism may work against other lenders. It is therefore the reason why commercial institutions cannot offer not more than 80% of their total value in real estate. In the past, these unions were completely barred from commercial lending.

Why Commercial Lending is more Risky Today

Commercial lending is riskier today than it was ten years ago. The observed change like commercial lending can be attributed to the following factors that go into the value chain. Benford and Burrows point out the fact that risks include “environmental risks, business process risks, information technology risk, infrastructure, and human resources risk” (48). If these factors are not well managed, they can make a firm unable to repay its debts.

One of the reasons why commercial lending has become very risky today is the dynamism of the environment. Such changes in the commercial environment today pose a big risk. Environmental risks affect almost all facets of a business. The risks can be ordinary, opinionated, or even financial. The most unpredictable commercial lending risk emanating from the environment is a natural risk that comprises fire, tornadoes, floods, earthquakes, or even hurricanes, which are the most unpredictable yet the most devastating. The second reason why commercial lending has become more hazardous nowadays is due to the increased rate of economic risks.

Economic risks can impair an institution’s borrowing ability. Catanach et al. point out how commercial lending ability is controlled by labor uncertainty, products, prices, markets, ability to control employment rates, interest and inflation control, and the ability to control wage bills (44). These factors may pose a great limitation to a firm’s ability to repay its debts. It is out of economic risk that most of the organizations have not been able to repay their financial debts.

Corruption rates have doubled in most nations today. Banking institutions are being dragged into hiring incompetent human resources. These institutions are hiring employees based on parameters such as blood relations, tribe, religion, or sex. As the vice becomes deeply entrenched in the economy today, the quality of human resource personnel hired by most banks is unqualified for the jobs they do. Corruption compromises professional banking services where the borrower, therefore, does poor investment education. According to Pacelle, Enron filed a legal suit on its banks for unprofessional advice (C1).

Therefore, a huge company such as Enron was very successful ten years ago has failed today due to unprofessional human resources in commercial lending institutions. Similarly, Catanach et al. observe that most of the current lending institutions and even the borrowing institutions have not put in place structures to control corruption (44).

Change in information technology has also made commercial lending riskier today. The level of competition in the application of information technology in today’s business is another risk for businesses today. It is therefore unpredictable for any investment on whether it will be able to make a profit, repay the loan, and move with the current information technology trends. The trends that are there today are completely different from those that were in place ten years ago.

Everything in commercial lending is now computerized. According to Brevoort and Hannan, both borrowers and commercial lenders are at the risk of decreased data security in computers, questionable activities on the internet like online fraud and access to other people’s classified information, and the ability of business processes to run smoothly in the competitive information technology world (1991). For example, some clients may need compensation if the company exposes their confidential data. Such inability will affect the ability of various institutions to repay their loans.

Conclusion

In conclusion, commercial lending is a commercial activity that firms undertake to ensure that there is a good cash flow within the organization. Commercial lending today is much different from how it was a decade ago. These changes have come through a reduced time of the procession of loans due to information technology, increased inflation rates due to the world economic recession, reduced period of payment, and flexibility of the lending process amongst other parameters.

The discussion also concludes that commercial lending is riskier today than it was in the past. The high degree of risk has been associated with environmental, information technology, and business process changes. If a company is not able to compete with its environment especially in information technology, it is likely to face displacement. As a result, its ability to repay its loan may become very difficult. It is, therefore, riskier to do commercial lending today than it was in the past.

Works Cited

Benford, James, and Oliver Burrows. “Commercial property and financial stability.” Bank of England Quarterly Bulletin 53.1(2013): 48-58. Print.

Brevoort, Kenneth, and Timothy Hannan. “Commercial Lending and Distance: Evidence from Community Reinvestment Act Data.” Journal of Money, Credit & Banking 38.8(2006): 1991. Print.

Catanach, Anthony, Robert Kemp, and Laurence Pettit. “Proper Loan Structure: The Key to Creating Bank Value.” Commercial Lending Review 1.2(2003): 43–47. Print.

Cecchetti, Stephen, Madhusudan Mohanty, and Fabrizio Zampolli. “The real effects of debt. Bank for International Settlements.” Wall Street Journal 1.352(2008): 1. Print.

Pacelle, Mitchell. “Enron Weighs Suing Its Banks for Bad Advice They Provided.” Wall Street Journal 1.50(2003): C1. Print.

Waterhouse, Richard. “The Vision Splendid: Conceptualizing the Bush, 1813-1913.” Journal of Popular Culture 33.1(1999): 23-34. Print.

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