How Banks Assess Your Risk Level

While the media talks about the lack of credit that’s available for small businesses it is important to realize that banks and lenders do want to make loans. They are in the business to lend money because that’s how they make money. The risk involved is minimized depending on factors related to the company’s sales revenues, credit standing, years in business, etc. However, due to the recent economic downturn, certain risks that banks and lenders were once willing to accept are no longer acceptable. This doesn’t necessarily mean that there is no money to lend it simply means that the standards have changed.

Less risk means lower rates and returns for the banks, but in this economy it is all about minimizing risk and exposure. Banks and lenders are more focused on lending to creditworthy businesses at a lower rate, rather than a riskier business at a higher rate, simply because of the state of the economy. The lending parameters of major banks are driven more by economic climate than anything else. For example, if the economy was booming than banks would be willing to take on much more riskier loans simply because the economy is in a healthy state. So what can you do to be considered as a low risk so your business can qualify for a loan or line of credit? Each of these areas plays an important role for lenders when determining your risk level: Capacity – This is an evaluation of your ability to repay a loan or line of credit.

This includes cash flow, payment history, and additional cash sources. The best way to show your capacity is with favorable business credit scores, a solid bank rating (minimum of a low 5), a well designed business plan and/or prior year(s) financials that show you can produce enough cash to repay the loan. Capital – Typically, a company's owner must have his own funds invested and at risk in the company before a financial institution will be willing to risk their own investment. How much skin you have in the game is very important and can make the difference between an approval and denial. Collateral – Commercial real estate, heavy machinery, business equipment, inventory, stocks and bonds, and other expensive business assets that can be sold if a business fails to repay the loan are considered collateral.

Conditions– Be prepared to prove that the conditions are right for your business. Make sure there is market potential, an industry, positioning, competitiveness, and experience to back up your plan. Character –Lenders have to believe that a business owner is a reliable individual who can be depended on to repay the loan. Some areas they look into include personal credit ratings, education, and work experience. When applying for financing, don't forget the importance of personal relationships. Apply for a loan or a line of credit at a bank where you already have a positive business relationship. Also, make an attempt to meet with the person who will be evaluating your application, such as a bank's lending officer, rather than the teller who handles your day-to-day banking transactions. The less risk you pose to a bank or lender the greater the chance you have for securing the financing you need at the best interest rates possible.