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23 Mar 2023

Unlocking the Secrets of Bank References

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Why Bank References Matter for Credit Managers

The failure of Silicon Valley Bank, the Signature Bank and recently Credit Suisse highlights the companies’ dependence on the performance of certain financial Institutions.
A lesson learned again; is your customer highly leveraged or not, obtaining meaningful reference from your customer’s bank adds value to your risk assessment process.
Read why you should excel in credit management here.

How a Bank’s Insolvency impacts their customers?

Banks are financial institutions that play a vital role in the economy by providing loans, safeguarding deposits, and managing financial transactions.
However, like any other business, banks can go bankrupt as you have seen with the Silicon Valley Bank’s case.

A banks’ insolvency may have significant repercussions for its customers.

Insolvency means that the bank is unable to meet its obligations, including paying back its depositors. If the country has a deposit insurance scheme in place, it can provide some protection to the customers.

However, even with deposit insurance, customers may still face some inconvenience and uncertainty. The bank might be temporarily closed and the customers may not be able to access their deposits until the deposit insurance scheme kicks in. Additionally, customers may have to wait to receive their deposits back, which can be a problem if they need the money urgently.

If the bank’s insolvency is severe, and the deposit insurance scheme is inadequate, customers may lose their deposits entirely. In this case, customers may have to rely on the government’s intervention to recover their funds, which can be a lengthy and uncertain process.

The bank’s insolvency can also impact its customers who have taken out loans from the bank.

In the event of the bank’s insolvency, the loans will be considered as unsecured claims against the bank’s assets, and the customers may not be able to access the full amount of the loan. Consequently, the customers may have to find alternative sources, which can be difficult if they need to secure credit from other lenders.

In conclusion, the bank’s insolvency can have significant consequences for its customers, including loss of deposits, inconvenience, and uncertainty. The impact depends on the deposit insurance scheme in place and the severity of the insolvency.

What information should a bank reference contain?

In your Credit Management role, you would be tracking your customer’s bank relationship and monitor key characteristics of their deposit – borrowing transactions.

By obtaining bank reference you will understand which financial Institution supports your customer and what are the potential risks of that relationship. You will also be able to test your customer’s character and liquidity situation through the inputs from their bank.

Bank references would usually contain the following information:

  1. Bank Information: name and location of the bank.
  2. Account Information: the customer’s accounts, the account number, account type, and account balance.
  3. Account History: the length of time the account has been open, any overdrafts or bounced checks, and any other issues that may impact the customer’s creditworthiness.
  4. Credit Facilities: details of any credit facilities that the bank has provided to the customer, including loans, lines of credit, and other forms of financing.
  5. Collateral: details on the type of collateral and its value which the customer has provided for the credit facilities.
  6. Payment History: the frequency of payments, any missed or late payments, and any other relevant details.
  7. Liquidity: the amount of cash or other liquid assets the customer holds.
  8. Relationship with the Bank: details on the length of the relationship, the frequency of transactions, and any other relevant details.
  9. Management Information: evaluation of the management and character of the business.

Overall, a bank reference should provide Credit Managers with a comprehensive overview of the bank relationship and insights into your customers liquidity position. By evaluating such references, you can make informed decisions about extending credit or other forms of financing to your customer.

References are Not Standard

Sometimes, it is complicated to obtain a bank reference. The best way is probably to go through the customer itself: once your customer agrees you will most probably get some data from their bank.

Content of the reference determined by the relationship of the bank and your customer, but also by the country’s and the bank’s Internal communication policies.
You may get a simple statement confirming the business relationship exists for some years, and the character is satisfactory.
If your customer’s bank is devoted to strengthening a “trust” relationship, you may receive the full summary of the account-, borrowing- and management details.
The stronger the customer and their banker’s relationship is, the more comprehensive details you may obtain.

When evaluating the received information, it is important to understand that the bank does not form an opinion about other creditors’ credit request, neither guarantees any payments of the company!

Rejection of bank reference might be serious “red flag” Indicating your customer’s bank Is not satisfied with the relation or considers withdrawal of the credit facilities.
In certain situations, rejection indicates the bank itself faces internal Issues!

Which Banks represent a Risk?

Most Western countries have strict banking legislation. In some countries however, legislation Is rather allowing, for example a bank can be set up already with $ 1 million capital in places such as Dominica, Gibraltar and Mauritius.

You will be fine to rely on the reference of a first-class bank. You should however scrutinize information received from offshore banks or financial institutions established in a weak, frequently changing legislative environment!

Evaluating the creditworthiness of banks is an important task, as it helps stakeholders to assess the risk associated with a particular bank, with regards to its financial performance, risk management practices, regulatory compliance, and market reputation.

Independent agencies such as Standard & Poor, Moody’s, Fitch, DBRS Morningstar, Scope Ratings, AM Best, Expert RA, Japan Credit Rating Agency, Rating and Investment Information, Inc. or China Chengxin International Credit Rating provide bank rating and detailed assessments of credit worthiness of banks. If your exposure is important, you would consult multiple rating agencies and consider their ratings in conjunction with other sources of information.

Bank insolvencies occur now and then

Bank insolvencies are not common, but they do occur from time to time.

To protect themselves, companies should regularly monitor the business reports of their bank to track their eventual issues. Keeping a close eye on the changes or irregularities of their bank will allow them acting quickly, if necessary.

Additionally, they should consider the deposit insurance scheme to ensure that their deposits are adequately protected.

Companies should strive diversifying their banking relationships and spread their financial risk across multiple banking institutions. This way, if one bank fails, their business will still have access to other sources of funding.

If they perceive risks or loose trust, companies should be considering alternative financing options such as credit unions, online lenders, or peer-to-peer lending platforms.

Why Bank References matter?

Bank references can provide valuable insights into your customer’s banking relationship, their credit worthiness, and their liquidity situation.
Is your customer highly leveraged or not, looking into the bank references can help you make informed credit decisions, optimize risk, and maximize profitable sales for your company.

Klass Academy is educational body of the Swiss Credit Association.
Klass Academy provides digital training, virtual coaching and live courses for Finance, Sales and Order to Cash professionals.
Would you like to know more about Credit and Financial Analysis? Visit our website or email contact@klassacademy.com.


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