Consumer Law

Banks Cutting Back Credit To Business

By Wendell Sherk, Missouri Attorney

Banks have been cutting credit card limits for consumers for several months now.  But consumers shouldn’t feel picked on.   It turns out the banks are cutting credit for businesses in a big way, too.

Large businesses do not finance their operations on a credit card.  Not really.  But they usually do have the large-scale equivalents of that ubiquitous piece of plastic: Revolving credit lines.  Most large businesses like to have a credit line or two in place with banks just in case they need some short term cash.  Typically a business prefers to come up with cash from its operations — selling products or services at a profit — or from its savings.  And a revolving credit line will usually bear interest rate terms and costs which discourage the business from relying on it for long (just as the higher rates and fees of a credit card should discourage consumers from carrying large balances for long).

Banks have historically offered these “revolvers” (as they are known) pretty cheaply.  Even though the bank might have to keep a small amount of capital on reserve for the eventuality where the business might draw on the revolver, it rarely charged much for the privilege of having a revolver (just as most banks rarely charge a consumer an annual fee for a card) so they could have a foot in the door for more lucrative lending to the business.  After all, in return for the revolver, the bank is likely to have a better look at the books and therefore a leg-up on the competition in figuring out risks and rewards of new loans.

But now the calculus is changing.  Banks are pulling back on available revolvers, allegedly across the board.  Citibank has reportedly cut its exposure by 35%, Chase by over 20%, and Bank of America by about 12%.  Overall, the new “revolvers” issued during 2008 could be less than 50% of those issued in prior years.  When that reduction is measured in hundreds of billions of dollars, it represents a serious reduction in credit available to businesses.

Obviously it’s hard to feel terribly sorry for the business community when the same thing is happening to so many consumers.  But many businesses rely on this short-term lending to stay in business when their own customers start running slow on paying for goods or services, they use it to bridge these gaps, and they meet every day expenses like payroll and to pay their own suppliers.

Of course sometimes they also use it to just keep the business alive, even when all real hope is gone, so there’s real risk to the banks here.  But ultimately the tight-rope of keeping a business alive is getting longer and narrower.  And it also means there’s less credit  — despite the government’s massive efforts to free up capital and credit — to get the economy going again.  It may be good for the long-term health of the large banks to cut revolvers but it’s another piece of bad news for the economy.

Full post as published by Credit Law Network on July 07, 2009 (boomark / email).