Sources of Financial Institution Ratings for the Small Business Borrower

Introduction

Many financial institutions currently possess adequate amounts of cash and liquidity to loan, yet are reluctant to do so. The "Great Recession" of 2007 through 2009 badly damaged many banks and the survivors are adverse to risk. These financial institutions have taken a very conservative approach to their lending practices to lend to those companies with the strongest financial fundamentals. These financial institutions will only lend to those entities which have the strongest leverage ratios and demonstrate the highest probability of repaying their debt obligations. These banking fundamentals are reinforced by vigorous interest of regulators in the credit quality of banks.

This creates a difficult borrowing environment for the small business borrower as many financial institutions will overlook the small business due to current lending practices. Small businesses represent too large of a risk to these financial institutions and are complicated to justify as risks to regulators. The key problem remains that small businesses are specifically require cash infusions to begin its business or to fund ongoing operations. The small business borrowers do not have that "bridge" to the financial institutions which have the ability to assist the small business.

This paper will not discuss policies to remedy this situation. Large-scale structural changes in the financial services industry would be necessary to change this and is therefore beyond the scope of this article. The Federal Reserve Board would have to implement fundamental changes which would require approval by the US Congress. The political discourse in and of itself would be overwhelming and would probably leave the small business still groping for a cash infusion for its business.

So where does this leave the small business? There are financial institutions willing to lend to the small business. These are not the multinational commercial banks. This may also rule-out large credit unions which have billions of dollars in assets. Many of these larger financial institutions are willing to lend to the small business, but the multinational commercial banks and large credit unions mainly focus on well-established corporations and industries.

Fortunately, many community banks and small and medium credit unions target the small businesses. These community banks and small and medium credit unions typically understand the needs of the small business and have operations built for small business lending. Small businesses are valuable and long-time customers for many community banks and small and medium credit unions.

A basic problem is that many community banks and small and medium credit unions are not well-known to the business community in general. Their advertising budgets may be at the bare minimum, many depend on social media as a marketing source. Like most small businesses, the community banks and small and medium credit unions do not have the financial resources for effective advertising. They focus on outstanding in-store customer service, and rely heavily on "word-of-mouth" advertising by members.

The community banks and small and medium credit unions may only have a single branch in the geographies in which they serve, so small businesses from other locations do not see the branch. This is a problem for small business, community banks and small and medium credit unions due to the disconnect between them. The community banks and small and medium credit unions can create a feasible business relationships however the cost of search for the potential business partner is high.

Problem Definition

If the small business does find a lender, how can the small business be certain the lender is financially viable? What if the small business establishes a line-of-credit, only to have the lender fail and leave the small business with an unanticipated cash shortage? An inherent problem is that the community banks and small and medium credit unions are not well-known, so the small business must somehow determine the viability of the potential lender.

An unfortunate consequence of this situation is that there are some unscrupulous lenders which are not closely regulated as the banks will take advantage of the small business. Most small businesses do not have the labor and financial resources to perform the due diligence on the potential lender and the unscrupulous lenders know this. The unscrupulous lenders may require nonsense upfront fees, unnecessary compensatory balances and usury interest rates.

The basic problem resides with the small business not being aware of information in order to perform necessary due diligence. Fortunately, there are free sources of data available on-line and through print that the small business can easily implement. In addition, there are many low-cost sources of information, many less than $1000. While this may be a large sum for a small business, there is potential that it is a critical source of information to the small business.

Sources of Information

One of the best free sources of financial institution ratings is "Bankrate.com" with its "Safe and Sound Rating System". Bankrate.com states that its ratings are "Comprehensive, objective, and free." and configures its ratings in a format that is indeed comprehensible. The financial statements are included and Bankrate.com has a rating system it uses to grade a financial institution. It also has a "Memo" link which provides a general description and forecast of the company to be studied. The user may choose "Banks/Thrifts" or "Credit Union",