Small Business Financing News: Banking Regulations Attempt to Reign In Risky Deals
A recent article in The Wall Street Journal addresses how financial institutions are increasing protections against unexpected losses. In the article, "Banks Get New Restraints: Historic Refashioning of Rules Aims to Trim Risk-Taking, Limit Future Crises," Damian Paletta and David Enrich explore the impact of the new rules are designed to ensure the interconnected global banking system doesn't face another crisis such as that which led to taxpayer-funded bailouts in 2008 and 2009.
The effects of these new restraints are likely to impact everything from mortgages to commercial loans in coming years. Officials want to rein in the kinds of risky activities that contributed to the financial crisis, including requiring banks to have large stockpiles of capital so that they will be able to continue lending even if the economy worsens.
In my opinion, all the capital reserves in the world is not enough buffer for making bad loans and doing bad deals. Marginal increases in capital requirements are nice window dressing, but the real issues are underwriting standards and product offers the banks are allowed to make. These deals are and were way too broad and risky.
Banks need intelligent regulation that keep them from doing too risky of deals. 100% private equity/hedge funds can do virtually whatever deal they see fit to. As you move into commercial banking with leverage and government guaranties and grandmother's savings, much more care must be taken in making loans or providing other financial products. So the banks are really too big to succeed without bailouts. They need to be restricted to certain types of loans and financial products that are relatively low risk, inexpensive, and provide a low rate of return.
The balance of the capital market requirements should be provided by private equity or special investment banks with minimal leverage where their own capital is at risk. The price point for these deals with regard to interest rates will be much higher, but better matches the rate of return required for risky deals.
Essentially, what happened is risky deals were getting done cheap during the boom because institutions that should not have been involved were. Those deals should have been done with private equity, at a higher price point and the sharper supervision that goes with private equity. That would have slowed the growth of the bubble… if not prevented it in the first place. Deals would have to had made sense at a higher price point and under closer scrutiny because private closely managed money was at risk, rather the OPM (other peoples money) always a risky deal.
Businesses also need to make smart decisions about when seeking alternative financing from private lenders or exploring recapitalization and financial restructuring to continue securing working capital.