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Are banks softening their commercial loan pricing standards?

Are banks softening their commercial loan pricing standards?

Commercial Loan Pricing update

Over the past few years, financial regulators have tightened their monitoring of banks to ensure that the mistakes that led to the 2007 financial crisis are never made again. For instance, they required large banks to separate their investment branch from their retail one to prevent excessive risk-taking behaviors. Similarly, banks were told to hold their lending rates at a level that reflects the creditworthiness of corporate borrowers. However, it seems that certain financial institutions are softening their lending terms.

Underpriced commercial loans

According to the Index of Banking Activity report between October and November 2014, commercial loan activity has increased. But this acceleration can’t be matched with a corresponding increase of the commercial loan pricing metric. The only explanation that can be drawn is that the loans distributed to businesses were underpriced. The readings for commercial loan activity and commercial loan pricing were 56.5 and 45.9 respectively. Readings that are above 50 denote an increase, while those that are below 50 indicate a drop for the given metric.

Why are commercial loans being underpriced?

As you might know, the banking sector is very competitive with players trying to steal account holders between each other. However, this competitiveness is raising serious concerns that may pose systemic problems in the long run. As they are trying to attract new customers, certain banks purposely offer financing to loan applicants who aren’t credit-worthy. Commercial loans should normally be priced so that they include all potential losses like if the borrower is unable to repay their debt.

While competition usually has positive effects, it should always be done properly. To avoid that such a reckless behavior spreads across all the players of the banking sector, financial regulators should act now and make sure that everybody follows the same rules. Please contact us to learn more about commercial loan pricing.

Alan Lee