Most bank pricing strategies are directly linked to a risk grade process. This processes assesses each business customer and ranks them based on an expectation of the probability of the business defaulting on its loan, and if it defaults, the probability of the bank losing money.
Whilst each bank will have a different risk grade process, the key ingredients are fairly standard and can be broken up into 3 categories:
1) Account Performance
2) Financial Performance
3) Customer and Industry Information
Account performance looks at the way businesses maintain their current bank relationships and every time the business overdraws its cheque account or is late with a loan repayment, then a black mark is applied. Even if you are looking for a new bank this will work against you as the new bank will invariably ask for bank statements and look at the historical behaviour.
The bank will also look badly at continual limit increases, and lack of adherance to scheduled principal reductions. Bad account performance is not only an indicator of solvency issues, but it is also an indicator of management integrity in the eyes of the bank. If a business is not in the habit of adhering to its bank arrangements, then it is likely a high maintenance bank customer. The bank would be thinking that even if it doesn't lose money from loan losses, chances are it will lose money from servicing costs.
Financial Performance is based on the last 3 years financial information and uses performance trends and key ratios to test for high risk customers. Obviously businesses that are making losses, have negative cash or cannot demonstrate ability to meet interest commitments will be penalised. However other indicators are less obvious; the fact that financials haven't been prepared for more than 16 months after year end, measures of leverage indicating that the business is not too reliant on external funds (bank or otherwise), liquidity - ie the business has more current assets than it has current liabilities.
Customer and Industry Information looks at the experience of management, the competance of management (note this includes whether management has allowed the business to go into debt with the Taxation office - an absolute no no in the current banking market), and the length of banking relationships. It also applies a specific weighting to the risk factor based on the bank's perception of overall industry in which the business operates. Certain industries will have negative risk influences, regardless of the performance of the specific business.
In most cases it is not possible to change a bank's perception of risk at a point in time. The measures are quite objective and clear. However a business, armed with an understanding of where their risk grade is being adversely impacted, can plan to make changes that will rectify this above and beyond financial performance.
If your business would benefit from a review of your risk grade performance, contact Pearl Financial Services who can perform a risk grade anaylsis and provide you with a plan for improvement.
