There is a lot of talk on the news and in the papers about the reluctance of banks to give small businesses loans, and how that reluctance is part of what is keeping our economy from rebounding.
Maybe one reason that the banks are not giving out lines of credit to small business owners, is because the banks have figured out how , in many cases, to extort obscene profits from the captive small businesses.
The scheme that the banks use is geared towards small businesses that are dependent upon billing out for their services, and receiving payment by check. Small businesses that work primarily in cash (fast food, storefront retailers, etc) have some immunity.
Here is how it works:
Acme provides services to other companies. When they receive an assignment, they schedule the work, buy the necessary materials, and assign worker(s) to the job. They write a check for the materials, and at the end of the week or the next week, they pay their labor.
Acme’s costs are almost immediate. And in a very slow economy like the one we are in, their orders are probably way down from previous years, and there is not much of a cushion between costs and billings.
Work is now completed, and Acme bills out the job, let’s say the bill in this case is for $1,000 even. If the billing is to a very good customer, or another small business, they will usually see their money in about 30 days (a month after they have already paid for the materials and labor) --- but if their customer is a large corporation, there is a very good chance that it will be 45 or 60 days before they get paid, as large corporations can, and do, use their payables as a floating line of credit when they need to …… in essence, taking a loan out from their vendors.
Acme is lucky on this job, and they do get payment of $1000 in about 30 days from the date of invoice. But that does NOT mean that they have their money yet.
They deposit the $1000 check into their business checking account at ABC bank down the street. ABC is a large bank operating is several states with over one hundred locations.
Since the check that Acme has deposited is from a company in another state, ABC puts a 5 business day hold on the check (7 normal days). This means that the $1000 is NOT available for use by Acme for another week.
In reality, ABC has put the check for $1000 into the Federal Reserve Clearing, and ABC receives interest for every day that check is in the Fed! That is the overnight rate that the Fed pays to banks. Of course when the money is out of the Fed, the bank uses it to makes loans and again, makes interest on the $1000 that Acme does not have access to yet.
It is worth noting, that virtually all the check transactions nowadays are done electronically, and the bank has probably received the $1000 for the check the day after they put it into clearing.
So the bank has the $1000 for a week and making money on it, while Acme is still waiting. But the best part For the Bank is yet to come. ABC gets more chances to make even more money off this transaction!
Acme has to write checks to its vendors and suppliers, and there are also monthly billings from their insurance company, vehicle loans, and other payables, that are automatically withdrawn from Acme’s checking account with ABC.
As luck will have it, during the float time that ABC is keeping the funds unavailable to Acme, some of those automatic withdrawals hit Acme’s account, and virtually used up all the “cleared” funds in the ABC account. When ABC deposited the check, they already had $3500 in the account that was cleared, and with the deposit, they have $4500 in their account, but there is that 7 day hold on the $1000.
After the automatic withdrawals, Acme’s “cleared funds are $750. Seven checks that Acme has written, totaling $1500 come into the account. There is a check for $900, and then six more checks for about $100 each.
ABC bank receives all seven checks the same day. It processes the $900 check first, which is $150 more than the available funds that Acme had in its account (there is still the $1000, but it won’t clear for 2 more days). So Acme’s “available funds” in its checking account are overdrawn by $150.
ABC bank charges Acme a $35 charge on the $900 check, for overdrawing the available balance. It then proceeds to pay the other 6 checks, at an additional charge of $35 per check. It has now assessed Acme $245 in overdraft fees.
When ABC finally clears the $1000 deposit two days later, it deducts the $245 in overdraft fees, so Acme only has $755 left of the original $1000. If Acme was making a 25% gross profit on that job which would be $250, they have now only $5 of that left.
In essence, ABC bank has “loaned” Acme $1500 for two days in covering the 7 checks, and made a return of $245 on the $1500 loan (16% interest for two days). A very bad deal for Acme --- a hell of a good deal and Great Profit for ABC!!! Remember, $245 for two days --- what astronomical figure is the interest rate based upon an annual basis???
I would suggest that the answer to the question I put forth above “Why Don’t Banks Want to Provide Loans to Small Businesses --- Even after the Government Bailouts and TARP Money the Banks Received?” is obvious.
Why in the world would a bank provide a small business person a loan or line of credit, at any imaginable annual rate (10%-15%-18%) when they can collect 16% on a two day loan?
By the way, this banking scheme, as many of you may know, is also used on individuals.
Please note that banks have not always been this predatory. In my own experience, I was with a large bank for about 15 years, and during most of that time, I could work with a branch manager and expedite the clearing of funds. But starting about 4 years back, they stopped helping to work with their customers, and took a “scorched earth policy” instead.
There is also some hope with SMALL banks. There are still a few (very few) small banks and savings and loans, that really do want small business and consumer business, and they will work with their customers. You have to look really hard to find them, but they do exist.
In my opinion the Large banks have done their expansions and buyouts, and they really don’t care much for small business or consumer customers. When they can borrow Billions from the government (us) and when their executives have paychecks larger than the budgets of most of the Milwaukee suburbs --- they just don’t care anymore…….
WHAT DO YOU THINK? YOUR COMMENTS ARE WELCOME!