Introduction the Bank Lending Framework

How did aggressive lending practices impact the 2008 Financial Crisis?

• In the US, banks were targeting clients for mortgages based not on credit fundamentals but on criteria favoured by Fannie Mae and Freddie Mac - the loan underwriting and distribution agencies
• The underwriting - or credit analysis and review within the commercial bank - seemed to decline in importance
• ‘Guarantees’ were in place from the underwriting agencies, so that banks would not be responsible for losses on mortgages they passed through to the agencies
• These factors encouraged dubious lending decisions and failed to protect borrowers from over-stretching their finances

What is the aim of a commercial bank when it comes to lending?

The bank is seeking a ‘banking return’ rather than an ‘investment return’, so they need to be conservative; they expect to make a profit on the lending and cannot afford many loans not to be repaid.

In the commercial banking market, ideally, the lender gets their money back with interest, but the bank does not share the profits or upside of success - so they should not be participating in excessive risk taking. This should be left to investment or equity financiers rather than bank lenders.

What sources of information does a bank use to assess a borrower?

• A loan or mortgage application form
• The account history of the customer if already known to the bank
• Any questions they care to ask during a discussion

• The internet
• Social media
• Credit databases
• Various company listings