The Risks You Know…

From The Economist: Pockets of Credit, Nineteenth Century Banking Makes a Comeback 

This month’s article highlights a number of new firms that are going after middle market lending when many banks and other financial institutions have retreated from it. Some new funds, using not-federally-insured cash are making bets on specific segments of the middle market with everything from senior to mezzanine debt; quite refreshingly they hold this debt to term, relying on their ability to judge the actual market risks of the obligors; they ride the wave of the actual company’s success (or failure).

An interesting part nearly glossed over by the article (as it wasn’t the focus) is the astute observation about why most traditional financial firms have effectively retreated from lending to mid-market and small businesses. In the wake of the financial crisis, banks are dealing with a huge amount of risk and uncertainty around everything from consumer demand, impending litigation, and forced reorganizations to a host of new financial rules and regulations that may or may not come into play. The reaction: Lower risks, increase liquidity, control costs. A resulting consequence: Less money for mid-market and small businesses.

“Among the reasons for this withdrawal are the managerial challenges of analysing the creditworthiness of small companies with none of the crutches that come from credit-rating agencies and the public data disclosed by larger firms. New, onerous regulatory demands tied to lending, not least rules requiring banks to set aside more capital against loans, do not help.”

Lack of risk data and un-informed regulations is a major driver of this pull back. These are two of the very issues WAIN Street thinks the Business Credit Health Index (BCH Index) could help with. When lenders are looking to reduce risk, they start by ridding themselves of the risks that they don’t fully understand. What’s better the devil you know or the devil you don’t? The risk you know, or the risk you don’t?  If lenders and regulators had better “crutches” and more complete data on these mid-market companies, perhaps the lending exodus would not have been so dramatic.