Conventional wisdom says that when one door closes, another one opens. While this isn’t always the case, it’s becoming increasingly true in the lending environment, where greater regulations on banks are impeding their ability to lend and paving the way for a new class of nontraditional lenders.
Of course, the door isn’t completely closed when it comes to middle market companies trying to obtain business loans from banks, but it’s certainly becoming more difficult. Banks are facing an increase in the amount of regulation on their lending requirements, which impedes their ability to offer loans to middle market companies. In the wake of the financial crisis of 2007, the government has implemented ever-increasing regulations on the banks.
And these regulations take their toll. For example, at the end of 2014, in a single division, a large financial institution had over 1,000 employees dedicated to the regulatory issues imposed on it. By the end of 2015, in response to the continued increase in regulations, that division had increased its compliance personnel to 4,000 employees. In the course of one year, the number of compliance officers in one division alone quadrupled, significantly increasing the organization’s labor costs without any corresponding increase in revenues, thus dramatically decreasing its profitability.
Increased regulation has also impacted the idea of “relationship lending.” In the past, if a company had experienced some challenges (like the loss of a large customer), and the business owner had built a good relationship with the bank over the course of several years, the bank would have had a fair amount of latitude in assisting the company through these difficult times. In today’s climate, however, banks have much less flexibility to work with the company and its management team due to the various lending regulations they are mandated to follow.
In light of the increased regulatory burden on banks, the door has opened up for nontraditional lenders to emerge. Now, with the banks’ hands largely tied by regulation, large pools of capital have been raised by institutional investors for the sole purpose of lending to middle market companies. These new non-traditional lenders can be very competitive with banks, and while they may be slightly more expensive, they can provide much needed liquidity to organizations with less requirements than a traditional bank.
It’s also unlikely that these nontraditional lenders will be going anywhere anytime soon. The new lenders are already able to offer competitive loans, so they’ll remain in the market for the foreseeable future, and a sweeping deregulation of the banks is improbable. So while the first door isn’t entirely closed, another door to new forms of lending has certainly opened wide.