Executive Summary: Most banks in the small business and middle market spaces continue to define themselves by their lending focus. That is a losing strategy and one that will be increasingly unsustainable.

The title of this week’s newsletter comes from the headline of an article in Tuesday’s Wall Street Journal. The lead paragraph states, “Banks and other lenders are engaged in an increasingly pitched fight for some corporate borrowers, raising concerns among analysts and regulators that the banks aren’t charging enough to cover the risk they are taking.”

Loans growth takes precedence.

The article goes on to quote an analyst who comments: “These guys [lenders] are kind of climbing over each other” for loans. The reporter also cites another analyst that “the need for growth is driving banks to deploy their excess capital into higher risk loans.”

While the focus of the article was on bigger leveraged-loans, we hear some of the same things happening in business and middle market lending. Regional and community bankers increasingly tell us about competitors who they say are squeezing margins and loosening terms to get deals. Banks, no matter their size, seem to remain fixated upon lending volume while oftentimes giving little more than lip service to building customer relationships that offer a strong earnings foundation as well as a platform for growth.

Let’s look at the current lending environment: fewer quality borrowers want to borrow; many risk managers have strengthened their banks’ lending standards and narrowed the credit “box” in which they operate; the cost of lending is often higher due to increased internal risk management activities and increased external compliance and regulatory requirements; for many lenders, margins are narrowing due to greater competition from hungry banks. Despite all this, too frequently RMs lead with lending. Why?

Why the loan emphasis?

There are at least three reasons why bankers continue to focus on lending.

First, banks have money to put to work and the need to generate earnings, both very understandable reasons for a loan focus. As the Journal quotes one analyst, “It’s the curse of cash.” Of course, we all need to be mindful of the earnings and growth pressures that banks face. Given the constraints on various other revenue generating areas for banks (including “free” checking, debit and credit cards, and mortgages) some banks have rediscovered business banking (rediscovered yet again in many cases). They see business banking as an opportunity to grow risk assets and replace the fall off in other areas.

There is nothing wrong with that focus, but for two things. That approach risks ignoring the 60 percent plus of business customers who do not borrow. Further, banks that primarily position themselves as business lenders usually fail to pursue cross-sell in a rigorous and disciplined manner. Unfortunately, at many bank managers view their processes as “rigorous and disciplined” when in actuality they are not.

Second, it is what bankers know best; it is in their comfort zone. We have found that while RMs usually (but not always) know lending products they often do not know other products very well. These other products are hardly exotics but rather what we consider core cash management and investment offers, usually fee based products that can significantly enhance the returns of a business banking portfolio or tie a company to a bank (for example, merchant accounts or remote deposit capture). Management often contributes to the lending bias by under investing in cash management and other non-lending areas. What is the ratio of cash management and deposit specialists to bankers at your bank? The answer: usually too low.

Third, loans are easier to sell than other products. Many companies have a time sensitive need to obtain loan or operate with a window for renewing/changing existing relationships. Usually, no similar time or need pressure exists related to cash management or other product areas. Customers need to be shown a product benefit that goes beyond low interest rates or high advance rates. The sales process for many of these products is longer and more nuanced. Going back to reason number two, lenders need help in order to assess non credit needs and determine how best to sell non credit products. Product specialists need to be given more prominence at many banks.

Next time: adjusting the loan emphasis.

With an assessment of bank needs, biases, and capabilities as a starting point, what steps should banks take to make the most of their loan efforts and build a stronger non-credit emphasis? In our next newsletter we will focus both on how to improve the lending effort and also build a more intense focus on non-credit opportunities. But, let me leave you with one other caveat concerning lending. A columnist in this Wednesday’s Financial Times writes: “Among banks, a macho pursuit of rates of return ? which were unattainable by soundly financed businesses in control of their risk exposures and operating in a competitive market ? led, not to efficient companies, but to the near collapse of the global financial system.” Lending was and is a risky business.