Fallacies in Banking

A fallacy is a “mistaken belief, especially one based on unsound argument,” and there are plenty of them in banking!

A common fallacy I have often encountered is the belief that quantity equals quality. Some lenders feel their most important credential is how many years they have spent in the industry of banking. But, just because someone has spent a long time doing something doesn’t mean they have been doing a good job at it. Other lenders like to brag about the size of their portfolio. Again, if they are mostly bad loans, does it make sense to brag about an exceptionally high number of them?

The most frequent fallacy I must address is the belief that collateral is the only thing necessary to justify a loan. Collateral is important to making a good loan, but it shouldn’t be the only reason someone is given a loan. Often times, it is tempting to give someone a loan just because they have a huge piece of land or ample equity in their home. But, this can turn into a disaster unless there is a source of cash flow. Without cash flow, the loan will quickly default and the lender will be forced to foreclose. Nobody wins with a foreclosure, which becomes a very expensive process for the lender.

The next fallacy is that you need to jump on the bandwagon. Just like your mother used to say, if all your friends jump off a bridge, would you do it too? Some lenders think they need to. Other competing lenders may offer more attractive deals to the borrower, but it may be at the expense of poor credit quality. Or, there is the belief that if we can’t give the borrower what they want, the borrower will find someone else to get it done. An honest discussion with your borrower may help them understand the reason for your lending requirements. Step back from the edge!

The most challenging fallacy to explain to people is that every great investment opportunity is not a bankable asset. What do I mean? There are risks we are willing to take with our own money that are not acceptable risks to take with depositors’ money. If I am offered a bet where I know there is a 75% chance I’m going to win, then I’m going to make that bet, if it’s my own cash! But if there is a 25% chance I’ll lose depositors’ money, then risk of loss is unacceptably high. We need the odds to be 99% in our favor before we can open the bank vault. Just because it is a good idea doesn’t mean the credit union should fund the idea. In other words, all good opportunities are not necessarily bankable assets.

I think most of the fallacies tend to snag people when they are in the heat of the moment. It's good if we get excited about someone's idea, experience, or the fact they have something significant to bring to the table. But, we need to calm down and follow standard underwriting procedures, and not let the excitement be the reason for making the loan.