Managing Your Financial Institution Risk
There are multiple risk factors that are included on any business’ financial statement:
- FX (foreign exchange) risk
- Geographical risk
- Accounts receivable risk
- Geopolitical risk
While these risk factors do provide a lot of insight into what can affect a business’ ability to grow, to acquire loans, and even survive through periods of uncertainty, there is another risk factor that could drastically change the financial outlook of a business. That risk factor is Financial Institution Risk.
What is Financial Institution Risk?
Financial Institution Risk is the level to which a business is in danger of losing the support of a financial institution that manages all that business’ debt. It is common for companies to use one financial institution for all their loans, from real estate loans to managing margins on day-to-day operations, and even equipment and vehicle financing. Many business owners are under the impression that a bank will have their back under any eventuality, but that is simply not the case. Banks can choose to divest on a company based on circumstances that are out of the control of the company itself, or the bank representatives that the business has been dealing with for the entire term of the loan.
A bank may choose to call a company’s loans to term whenever they have the legal right. This could mean total disaster for a company of any size, from mom-and-pop shops to multi-million dollar, decades-old businesses. If a company has all its loans with a single financial institution, it could be at risk of losing everything, including its ability to continue its operations.
Where Can High Financial Institution Risk Leave You?
Let’s say, for example, that your business is owed money from a customer for an invoice you have filed, and that customer is refusing to pay the invoice in an attempt to get a better rate from your business. It’s likely that you were counting on the money from that invoice to keep your operating line balanced and make payments such as payroll or other costs. Now, you will likely need to contact your financial institution and move that amount to bad debt as you negotiate with the customer to get as much of that original invoiced amount back as you can.
While these negotiations are taking place, you could decide to refinance your property and reinject that liquidity back into your company so you can continue to operate throughout the negotiations.
At this point, your financial institution could determine that your company is offside on your covenants. This will mean that your financial institution has the legal right to call all your loans, on all your business’ property financed through this single financial institution, to term.
If your business is unable (as is likely) to repay all of the loans, the financial institution will take equity out of all the financed property to balance your debt. The worst part is that the original customer will know that your financial institution has recalled your loans, and will understand that they can now negotiate the original invoiced amount down to a ludicrously low amount. That could lead to your financial institution taking out even more of the equity from your financed property to recover the full debt amount. This chain of events, stemming from a single unpaid invoice, could leave your business with almost nothing, and unable to carry on operations. This might sound like a horror story, but it is truly a possibility if your Financial Institution Risk is high due to keeping all your debt with a single bank.
How Can You Mitigate Your Financial Institution Risk?
By diversifying the loans a company has across multiple financial institutions, the risk of losing everything is drastically reduced. To mitigate Financial Institution Risk, a company can choose to use on financial institution for its real estate loans, another for its equipment financing, and another for its accounts receivable financing.
There are more benefits to shopping around your loans to other financial institutions. Should you decide to diversify your lending across multiple financial institutions, that will not go unnoticed. Financial institutions are far less likely to creep up your rates or fees if they know that someone else is at the table who is prepared to offer you better rates.
HGA Finance can help you diversify you financing, and help you control your Financial Institution Risk by meeting with banks and negotiating on your behalf to get you the loans you need with multiple financial institutions.
