Market and Bank Financial Lending Systems - Essay Example

Comparison Between Market and Bank Financial Lending Systems Since the economic explosion of the1990's, a lot has changed in the way the American economy has been developing. Although due to the recent war and transfer of power in the World Bank, many credit institutions are thriving. After approximately 2002, people began to spend the money they had saved up from 2000, and are once again beginning to freely spend it everywhere. Businesses are booming and expanding all over the place despite a recession. But, where does all of this economic growth come from And how can we continue to expand the new economic wave without falling into the dark hands of recession By using lines of credit and loans, many businesses are able to get off of the ground running. Banks, however, may no longer be the most reliable and best way to go about getting these loans though. Credit unions and privately held financial groups are beginning to make a huge emergence. We will analyze why this is happening and the differences between the lending structure of banks and private groups. Issues dealing with private reputation to company advertising, as well as government regulations on loaning will also be touched upon. A lot has changed and a new wave of economic development is slowly building up. Before we can begin to fully analyze the differences between the two economic structures, we must begin to learn a bit of history between the two methods. Banks have been one of the most popular methods of savings and lines of credit. Although, all of this has changed slightly since the Great Depression. During the Great Depression was one of the best examples of a bank run. A bank run is when people hear that a certain bank or institution is going to fail and all immediately head towards the bank or institution to withdraw all of their assets as quickly as possible. Of course, this created huge problems and created a time of economic disparity. However, since then, many regulations and organizations have been developed to prevent this from happening once again. The FDIC currently has the assets to insure any account within nearly any qualifying bank account up to the first $100,000. In this way, if something were to happen, the government would simply match the person's lost assets up to the first $100,000. This has helped to rebuild the trust between the common man and the banking system. But this is only the checking and savings side of the story. A lot of faith has been lost and for good reason in the banking system for credit. Even application processes have become long, tedious, and often uneventful when trying to receive a loan from a bank. And if you fail to receive a loan, it is marked against your credit score, which makes it more difficult in the future to attempt to get a loan. Government regulations are rather relaxed on the banks for their credit loaning. However, banks generally dislike entering into any high risk or highly volatile loan agreements. As such, it has become increasingly difficult for businesses and regular people to receive loans from banks 1. Processes must be backed by the banks assets, and although many banks have a large amount of assets, many just cannot compete with the assets of some large corporation who hold private financing groups. Not to mention that banks benefit less from issuing loans out to people and businesses. Sure they can extract a high interest rate and make a lot of money, but it one of the primary methods for a bank to earn its money, so it doesn't help any other factors other than to solely improve the cash-flow of a bank. There are several benefits for private firms to issue loans out to people though. Another problem with banks in recent years have been banks knowledge of how weak people have become to their regulations. Your credit score can now rule who you are, and people will do anything it takes to maintain this. In consequence to this, however, many banks have begun methods of "predatory loaning" where they offer an initial interest rate and set amount which must be paid per month initially 2. However, during contract signing, clauses are often mentioned which state that "interest rates are subject to change" and many bad factors can come from this. For instance, interest rates may suddenly soar and the amount due within the first few years may be increased. In this way people must give up more of their assets to make payments, or else they miss a payment and have to pay out huge interest charges. Often, the higher interest is only for the first few years, but this is when the loan is fresh and there is a lot to collect interest on. The bank with the largest reputation for this kind of loaning is Wells Fargo. To fully understand the consequences this predatory loaning method can have on people, we will look in depth at a particular case dealing with Wells Fargo 12. In Minneapolis Minnesota, there are several Wells Fargo Home Financing institutions scattered around the Twin Cities Metro Area. They are, of course, wholly owned by the Wells Fargo Bank and are built to help support Wells Fargo. There have been several cases recently where the Home Financing companies offer to refinance people's mortgages. However, they don't tell them about the interest increase clause and more often than not, increase closing costs and interest rates on people without their consent 4. However, once you refinance, you must take the new interest rate. Take for example Richard Morneau, who recently had received a home loan for $162,652. When he first took out the loan, his interest rate was only 7.875% and after insurance and taxes, his total monthly payment came out to be $724. He was offered a chance to refinance his mortgage, and took the offer up. However, after re-financing, the new terms were more than a bit startling. The company had re-financed them at an 11.98% interest rate, and their total monthly payments, before insurance and taxes (which totaled an additional $150) came out to be $1,950 13. The new terms also included a new $8,500 closing cost. You could imagine the grief Mr. Morneau went through to attempt to re-build his credit from months of difficult payments, and unfortunately, also had to take loans from the same Bank to help pay off the mortgage. This is just an inkling of the shadows looming over bank lending. Banks are concerned with one thing, their own financial situation. This in no way considers the benefit of the community nor the public. Granted, America has a lot of debt to take care of at the moment, but it is always said that you must spend money to make money. Since the induction of many predatory loaning techniques similar to these by various banks around the country, some groups have started up in response. Probably one of the most prolific groups is ACORN (Association of Community Organizations for Reform Now) which was established to help people in dire situations. One of the most powerful movements by ACORN has been its sister organization, ACORN Housing. The two have been working hand in hand to help and eliminate the dark practices conducted by Wells Fargo. Banks have been losing their reputation as reputable loan givers, and as such are being used less and less by the general populace. ACORN has won several lawsuits against Wells Fargo, which has done nothing good for the banks across America 14. This isn't the only problem people have been facing with the banks. One popular method of gaining funds for banks comes in the form of overdraft charges. The standard rate for a chain bank is $33 for any fee which goes over a persons account balance. Say, for instance, you have $20 in your checking account and decide to make a $50 purchase. As a way to supposedly pay for the paperwork, banks would make your account a total of -$63 by first subtracting the $50 from your account and imposing the $33 overdraft charge. But at first the system seems legitimate enough, until you look into how it works a little bit deeper 17. Several banks use checks as a way to help themselves extract overdraft charges. Whenever you deposit a check into your account, the actual amount usually isn't deposited for two to five business days. During this time you may write out a check or use a check card, and although the funds are supposed to be available after the first day, this isn't often the case. Many banks will hold your check and wait to deposit it. In the meantime, they'll subtract any transactions from your account as normal, but they will make you go negative first, and impose as many overdraft charges as possible before posting your check into your account. However, even if you can provide documentation which shows that you deposited your check first, banks have accounting practices which are much different than any business practices, and thus can float your checks until you go negative first and then decide to post it. Many banks have been making a mint off of overdraft charges because most people will only overdraft on a small, usually $5-10 purchase. Of course the profit margin is huge on transactions as small as these. In this way, banks have lost even more trust throughout the general populace and alternate methods of loaning and money handling have been sought out. Now we come to private institutions and private loaning. Basically, due to fewer government restrictions and generally a larger asset pool to collect form, private financial groups are much easier to handle getting a loan with and can often hold a higher volume of credit line. Also, most corporations realize the value in venture capitalism and will easily give out a large loan to businesses starting up, even though they are more volatile. They often affix a lower interest rate to the loan and know that people will respect this and it makes it much easier to collect on what is owed, since most businesses can generally turn a profit when given the right amount of assets. Even personal loaning is easier because financial groups can enforce stricter methods to gain what is owed to them by a private loaner, and as such as more apt to give out loans to people 16. This form of loan handling has multiple reasons why it spurs economic growth more than banks. First of all, by allowing people to spend more, they improve profits and revenues for other businesses where the loan is being spent, and by creating lower interest rates, people are able to make payments 3. Large corporations, by offering huge credit limits and multiple loans to people can make quite a mint off of people who pay on interest. In this way it helps the consumer get what they want, and local businesses by increasing their revenue and overall profits. And, this helps the company who issued the loan financially by making profits off of the interest rates which are imposed. This is basically a win all situation. As far as loaning to businesses goes, it has become much easier for new businesses to receive the financing they need. Most corporations understand that it can cost a lot to start up a business, and as long as somebody has a good plan of action for their business, many private firms are much more amiable towards lending larger amounts. These loans can often be high risk, but as such, the corporations are entitled to offer higher interest rates. In this method the corporations are turning an even higher profit while allowing business to expand everywhere. They say that when equipment is bought on loans, people often work harder to make their business succeed since they know they owe somebody something. In this way, it often helps businesses to try that much harder to make it all work out, and whenever a business succeeds, the whole community benefits 5. However, expanding other businesses isn't one of the best reasons why private firms are more apt to loan. With loans comes advertising. Word of mouth is proven to be one of the most powerful advertising methods out there. I know this personally since I am also a direct salesman in a company which uses no paid advertising, yet grosses over $200 million in sales each year. When you allow people an opportunity to start their business, and they succeed, they will always talk about the company which helped them achieve their dream. When something personal like this happens, people have a more profound effect on the decisions of others who are considering getting a loan. This is fairly common sense because you should know that when somebody you know tells you that something is good, you are more apt to try it out yourself. Private firms realize this and have made application processes easier, and payment methods a lot smoother. Private firms can even offer up their own services and products as a package with the loan. Many private lending firms offer up their products at discounted prices to businesses who take out a loan with them, and in this way advertise their product and increase revenue in sales as well as through credit lending. More money is spread around, and this helps to insure a stronger trust between the lender and the loan taker. It also helps to insure the lending corporation that more money will end up in their hands sooner because they are receiving some of it back. And whenever someone trusts you by buying your product off of your own money, it just seems a lot more personal and a lot higher chance of them paying you back 8. Also, loan officers and counselors come into play in the whole grand scheme of things as well. Although banks do offer loan officers as well, they often serve to only help the bank and give out strict guidelines. There is often little to no room for flexibility and bank loan officers tend to be more disgruntled due to lower pay. However with private corporations, they utilize loan officers to their fullest potential. The pure essence of the job of being a loan counselor or officer for a private firm is much more personal and amiable towards the consumer 6. Not to mention corporations can often afford to offer higher pay and compensation. One of the most profound things that private financial firms do to help the success of their loan officers is to offer up commissions. When you give someone pay based on commission, it makes them more apt to work harder and make the sale. Loan officers will often go to the house of the person who wishes to receive a loan, and unlike banks who wish to get everything to go their way, will negotiate with the person to help them receive things in their favor. This can often lead to lower interest rates for the smart negotiator, a plan of action to pay the loan back and a new found trust between the financial group and the person receiving the loan. It is often more comfortable for someone to talk about finance and come up with a solution within their own homes, rather than behind a desk at a bank. Being personal is always a big thing in the world of loaning and credit. Loan officers can give guidance and solutions to common problems on the spot and often keep close tabs with their clients. Banks, although they do monitor everything electronically, often deal less on a personal basis. In this way, clients feel more obliged to pay off their credit line and spend it much more wisely than when they feel un-monitored, such as the case with a bank. Another important issue and difference between banks and private financial groups is how they handle their information. Whenever you apply for a loan or credit, the firm or bank keeps a record of all of your personal details, and often submits this to the government for their record keeping as well. However, with more restrictions on personal firms about information sharing, there have been many differences between how information is handled between the two 7. Banks often feel obliged to give out any credit information to as many sources as they possible can. By selling database lists they can increase their revenues, and they also give a heads up to other groups looking for vulnerable prospects or to avoid people in total if they have a low credit score. When other firms and companies know this information, they are less apt to work with somebody to give them a loan. However, if they don't know all of this information right away when they see someone, they can often and will often work with somebody first to get the whole situation before passing judgments. Personal corporate and financial groups are under a tighter leash when it comes to the transfer of personal details about somebody 9. They are often not required to hand out personal credit details, and as such somebody can get away with multiple loan applications with private firms without ruining their credit scores. This helps the consumer by allowing them to personally filter through many groups and organizations and find the best loan for them, and then to see which ones they qualify for before any pre-judgments are given. This also helps the consumer and the general economy as a whole because when people spend more, the economy always becomes much stronger. Banks however, know that they can often freely share information, and abuse this power. This way, they can insure that a person will be dealing with only one or two banks at a time, and if they make applications to both, both might reject them and they won't feel as if the customer was worth anything anyways. This can create a vicious cycle for people in the long run, especially when looking for a home loan. Banks also know that with fewer applications being accepted, people will often have to deal with higher interest rates and closing costs, and as such will do anything within their power to negotiate the highest rates without losing the customer 10. Of course, there is the fact that people enjoy their privacy. Whenever you apply for a loan at a bank, often you may receive offers in the mail you never requested and spam email with multiple offers. If you check into some of the e-mails you may receive, you might be horrified to know that other groups you've never heard about know your social security number (as this is the most commonly used identification with banks) and where you live 11. Other groups can even purchase database lists on-line from banks with personal details like your occupation, income level, marital status, children, assets and just about anything else. And many of the on-line services are as cheap as $20 for a monthly unlimited access search. This allows other banks and firms to custom tailor loan information for you and entice you into something you might not need, but according to your economic history, are more apt to go for. This is very alarming and is a blatant invasion of privacy, however it is not against bank regulations. Identity theft is also on the rise in the past few years. So many more Americans are victims and are losing a lot from it. The main reason why this is is because people usually get their credit cards and lines of credit from the bank. With just a couple of personal details, a hacker can use a search database from a bank to purchase your personal information, and then use your credit card for whatever purposes they desire. Dealing with the banks is also a nightmare when it comes to identity theft. Because it is difficult to find the source of the problem with a bank, you can spend literally years attempting to become reconciled for just a few purchases you did not make. And since credit lines aren't required to be FDIC approved or insured, banks often times can opt to simply impose the fees and penalties on the consumer to handle. Private firms, in maintaining their reputations, are a lot easier to handle if something like this happens. Financial groups also generally have the assets required to pay back anything that happens and will often not mark identity theft on your credit score. It is much easier to find somebody more amiable to speak with face to face since financial groups also have better office hours than banks do. Many even have prepared offices to specifically handle identity theft 15. This way, they are prepared ahead of time and can make the whole process that much quicker. Being a personal victim of identity theft, I was able to reconcile my balance and receive my credit back within a couple of weeks and little to no paper work. However, a friend of mine, since recently having $800 in charges on his account at a bank, the bank has frozen his accounts, imposed nearly 6 overdraft fees and are currently seeking a lawsuit against him for supposed fraudulent gaining of funds by asking the bank to remove the amount. The company which charged that amount insists he made the purchase, even though they don't have documentation to prove it thus far. It could take a couple of years before he gets his situation fixed, and in the meantime he's been looking for another place to bank. All in all, although banks have been the most popular method of economic growth, they are quickly becoming one of the least reliable sources. Private enterprise is taking a new face in the modern world and is helping to facilitate strong economic growth, even during a time of recession. In this modern day and age, businesses are becoming more personal, which most people enjoy. This gives people a larger sense of trust with companies and allows them to get more loans. When people have more money, the spend more and put more back into the economy. It is fairly plain to see why market based financial systems are the superior method of economic growth. Whenever you de-regulate how business is run, people tend to show the good side of themselves more and help each-other out more. Laissez faire is an important cornerstone in today's free world market, and it should stay that way. Banks are still regulated by the government, and obviously have been failing to keep up to par. The choice is obvious and hopefully the government begins to support private financial groups more in the future. 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Department of Labor, Loan Counselors and Officers, Last modified Feb 7, 2004, viewed December 8, 2005 Received from http://www.bls.gov/oco/ocos018.htm 7Javier Carrillo, Endogenous Growth Theory, viewed on December 8, 2005, Recevied from http://www.knowledgesystems.org/e100mty/inputs/General_KBD_inputs/kbd_files/005_endogenous_growth/sources_endogenous_growth.pdf Used to receive further sources and information on the topic 8Deepthi Fernando and others, The Global Growth of Mutual Funds, May 2003, The World Bank, e-paper reference Received from http://wdsbeta.worldbank.org/external/default/WDSContentServer/IW3P/IB/2003/07/08/000094946_03062104294247/Rendered/PDF/multi0page.pdf 9Mark Carey, Mitch Post, and Steven Sharpe, Does Corporate Lending by Banks and Finance Companies Differ, June 6, 1996, various information researched, in particular on pgs. 1-7, 9-12, and 20-25, viewed on December 8, 2005 Received from http://www.federalreserve.gov/pubs/feds/1996/199625/199625pap.pdf 10Stijn Claessens, East Asian Corporates: Growth, Financing and Risks over the Last Decade, World Bank, viewed December 8, 2005, comparisons between American Corporate lenders and lending trends throughout the world, in particular pages 5 and 9 used, Received from http://faculty.fuqua.duke.edu/charvey/Teaching/BA491_2000/Claessens_East_asia_corporates.pdf 11Richard Gamble, Corporate Finance, November 2005, Viewed on December 8, 2005, Available at: http://www.treasuryandrisk.com/issues/2005_10/aha_award_winners/469-1.html 12Responsible Wealth, Wells Fargo Under Fire for Predatory Lending, April 14, 2005, viewed on December 8, 2005, definition of predatory lending used, available at: http://www.responsiblewealth.org/press/2005/WellsFargopr.html 13STRIDE, Wells Fargo Wants to Steal Your House, Minnesota e-journal, Viewed on December 8, 2005, available at: http://www.stride-mn.org/newspaper/Insight-wellsfargo-StealsYourHouse.htm 14ACORN, About ACORN, 2005 ACORN, definition of ACORN garnered here, viewed December 8, 2005, available at: http://www.acorn.org/index.phpid=2703 15Spiros Bougheas, Paul Mizen and Cihan Yalcin, Access to External Finance: Theory and Evidence, October 2004, University of Nottingham 16Sam Vaknin, Ph.D., Cyclopedia of Economics, 1st Edition, 2004, Narcissus Publications Sections on bankruptcy and liquidation, corporate economics and financial statements of banks used 17Wikipedia, Wells Fargo, Modified December 4, 2005, Viewed December 8, 2005, available at: http://en.wikipedia.org/wiki/Wells_Fargo Read More