Commercial lending – lending to businesses – is really a two-tier market in the United States. At the level of large companies, commercial bank lending is not as momentous in the United States as in many other countries, as there are a larger number of accessible alternative sources of funds for businesses. For small businesses, bank lending is often a crucial source of capital.
Business lending includes commercial mortgages, equipment lending, loans secured by accounts receivable and loans intended for expansion and other corporate purposes. Normally, the residential construction industry has been a major borrower; using bank loans to acquire land and pay for the construction of apartments or houses, and then paying the loans when the dwellings are completed or sold. Many banks effectively “double dip” in their lending to the housing market, lending money to buyers as residential mortgages, and lending to developers and contractors engaged in building new homes.
Business lending can also take the form of mezzanine financing, project financing or bridge loans. Mezzanine lending is not all that common for most banks, but project financing and bridge loans are often extended on a short-term basis, until the borrower finds a more permanent source of funds.
Banks also frequently use their capital to acquire investment securities. Regulators in all countries require that banks hold back some percentage of capital. Financial securities issued by the national, state, and local governments are frequently treated as cash by regulators. Thus, commercial banks will often hold these instruments as a way of earning some income on their reserves.
Many banks will also buy and hold securities as an alternative to lending. In cases where prevailing loan rates are inadequate to satisfy a bank’s risk-weighted pricing, some securities may be more alluring as alternate uses of capital. Accordingly, the bank sector is a major buyer of government debt securities. Commercial banks are also predominant buyers of municipal bonds. It is less common for banks to hold common stock. Though many common stocks do pay dividends, U.S. regulators have traditionally punished equity holdings by giving them poor risk weightings.
It is much more common overseas for banks to hold equity. Many banks in Europe and Asia view their relationships with businesses as something akin to partnerships, and will hold assets for a number of reasons, including both a stake in the upside of the company, as well as the influence that significant ownership can provide.
Fees On Deposits and Loans
Customers may revile bank service fees, but they are a large part of how many banks make money. Banks can charge fees for simply allowing a customer to have an account open, normally if, or whenever, the account balance is below a certain break-point, as well as fees for using ATMs or overdrawn accounts. Public banks will also earn income from fees for services like cashier’s checks and safe deposit boxes.
Banks also frequently attach a host of fees and charges when they make loans. While banks gamely try to defend these fees as important to defraying the costs of paperwork and so forth. Congress and has moved aggressively, to restrict some of the fees that banks can charge customers. In many cases these new rules simply mean that customers have to actively select and approve certain account features, like automatic overdrafts, but there are increasing limitations on what services banks can charge for.
Insurance is another surprisingly popular non-banking activity for many banks. Perhaps the popularity of insurance is due to its similarities to banking; both businesses are predicated on adequately evaluating and pricing risk. Both businesses also happen to be regulated, though insurance is mandated almost exclusively at the state level.
Likewise, given the similarities between lending and leasing, it is perhaps not surprising that many banks establish leasing programs. Relatively fewer banks look to take ownership of the underlying assets, but many banks look to form financing relationships with inventory dealers, paying a fee to the dealer for every leasing agreement signed, and then collecting interest on the lease. For example, these programs allow banks to expand their business lending, while leveraging the infrastructure of other businesses such as the equipment dealers.
Treasury services are a broad collection of services that banks will offer to corporate/business clients, such as company CFOs or treasurers. In addition to simple services like deposit-gathering, banks will also help businesses manage their accounts payable and accounts receivable. Managing working capital and payroll is a significant headache for many businesses, and while commercial banks charge for these services, many clients find that the charges are less than the cost of fully staffing and operating their own treasury functions.
Although making mortgage loans and collecting the interest is certainly part of everyday “interest income” operations at commercial banks, there are aspects of lending that fall into the non-interest income bucket. Commercial banks are willing and able to loan out money, but not especially well-equipped to operate the back office tasks that go into servicing those loans. In situations like this, a bank can sell the rights to service that loan, collecting and forwarding payments, responding to borrower questions, handling escrow accounts, etc., to another financial institution.