The Emphasis Upon Credit

Banking and lending is like any other business. They buy a product in, and sell it out, hopefully for a profit. With the lenders, the product they have is money. But if you consider their gross margins you will understand why their emphasis is on credit worthiness - as lenders HATE losses with a passion

Consider the simple example.

Take a manufacturing company that borrows $1M at say 10% per annum in interest. Let's say the lender borrows funds in the securitised marketplace at a cost of funds of say 6%.



Before service and ancillary fees the bank every year will make 4% GROSS PROFIT on the loan - i.e. $40,000 for their downside risk of $1M. Ask yourself if you ran a business that had 4% gross margins how careful would you be about who you sold to?

Let's say they advanced this money unsecured and the borrowing company goes bust. They lose $1M. Now to cover the cost of that bad debt they would need 25 times the volume of new loans just to cover the loss they have just made - in other words they would need to lend out $25M to cover a bad debt of $1M.



Now if we have a credit crunch how confident would the lender be about being able to borrow an additional $25M?

So if the lenders get their numbers WRONG...the lenders are in danger of being in serious trouble - hence they are risk averse.......