Asset Based Lending
Chief Investment Officer
Commercial Loan Automation
BirdsEye Viewa banker's perspective on, "an indebted student's perspective on the student loan fairness act"
As I read through my sister's article, "An Indebted Student's Perspective on the Student Loan Fairness Act". I couldn't help but feel some inherent disdain for banks in the subtext of her innocent plea for clarification of something she was fervent to grasp, and rightfully so. I think it really sank in somewhere around, "The Bank does, and banks (like all institutions, in [her] humble opinion) do not have a conscience." This overarching statement unfairly casts a cold assumption across an entire group of organizations that I believe do have a conscience in the collective will of their shareholders, board of directors, employees and customers.
In the wake of the recent recession and the questionable practices of various financial institutions, the financial industry has created a public relations nightmare. The word "bank" has begun to conjure spine tingling sensations associated with the economic downfall following the sub-prime mortgage crisis. I always picture a farcical image of a skyscraper with an overcast and smoggy skyline, topped off with a crackle of lightning and some daunting organ play to set the mood. But, it is an exaggerated image like this one that is beginning to compound miscommunication between banks and consumers. My beautiful, eloquent, and wholesome sister touches on what I believe is a crucial lingering dissonance in the banking industry between bankers and their customers.
After recent events in the financial sector, consumers feel they can no longer trust the banks, while the government is drastically throwing billion dollar Band-Aid's at wounds they do not fully understand trying to calm the masses. All the while the banking industry has been reacting to a recent recession. These forces have prevented the industry from attaining essential efficiencies that would be beneficial not only to consumers and banks but the United States economy as well.
The relationship between banks and their consumers, but even more so, their retail consumers, the 99%, the little guy, has been severely tried by recent events. "At the end of the day, I do not trust my bank, or any bank, to have my best interests at heart." For too long this idea has been allowed to propagate and deteriorate the already weak relationship banks have with their retail consumers. With the decline of customer presence in branches and the increased use of online and mobile banking, the communication link between banks and their retail consumers is taking on a new medium, creating the opportunity for banks to find new was to know their customers and understand their needs.
According to the Edelman Global Trust Survey of 2013, consumer trust in businesses is on the rise and back to 2011 highs. What the banking industry needs to focus on is the fact that US Trust in the banking industry has double among the informed public from 25% in 2011 to 50 % in 2012, but still remains below the 2008 level of 69%. US bank's performance ratings in lending to small business, providing home mortgage loans, offering reasonable credit cards, trading and investing in government debt, and overseeing initial public offerings, are all less than 40%. The US financial industry has a performance rating of over 50% in only one category, ensuring the privacy and security of customers' personal information. But that's a gimme; this is the banking industry. One of the more alarming statistics is this: in a survey respondents who reported being familiar with the banking/financial services scandals over the past year were asked, "What do you think is the biggest cause of these scandals" and 59% of their collective responses to the perceived causes of the scandals were believed to be internal and under the banks control. What this means for the banking industry is this: while consumer trust in banks is garnishing strength, the root cause of distrusts is the perceived public image that banks have created through the deterioration of the relationship between banks' upper management and consumers. So far banks are trusted only to successfully hold personal information. The banking industry, to consumers, is only as good as the steel vaults used in late 1800's to store gold. Banks need to get with the times and successfully connect with their clientele, to create a strong and lasting relationship.
In his article "How Can Bankers Recover Our Trust", Steve Denning touches on the issue of distrust in the banking industry. He offers Amazon, Apple and Google as good examples for banks to model in order to create a culture that promotes positive relations with consumers. Each of these companies not only has their consumer interests at heart but they also make a concerted effort to make their consumer aware of that fact. He also offers the example of Southwest as what not to do. Like some of the banking giants in the financial industry, Southwest tends to treat their consumers like a single archetype offering the same package to each faceless transaction that comes along, but at a great price! The middle market of the banking industry needs to fill the void between consumer desires and the reality they face in today's market. Let's be Amazon, not Southwest.
As it pertains to the Student Loan Fairness Act the relationship between the bank and the customer is disrupted by the legislative impact of government. Student loans are not economical for many banks due to government regulation and compliance standards. That being said, the act misses the underlying issue behind rising student loan debt. By focusing the spot light on the relationship between the bank and the student, government misses the flaws arising in the relationship between the student and the institution of higher education. With the demand for college level education rising and the supply of reputable institutions remaining relatively stagnant, the price of education is surely to go up. The banks merely act as a middleman to provide financing for those who cannot afford to pay the university themselves. "Is this piece of legislation the way to fix that?" No, and added government intervention, like this one, will only further inflate the price. I believe the right piece of legislation here is one that promotes innovation in the mediums of higher education and confronts the issue of supply rather than shifting the financial burden of rising education costs onto the banks or the taxpayers. The government and the financial industry must find ways in which they can work together in order to combine their expertise to meet complex issues such as financing education.
Here's a quick recap of student loans as I've come to understand them. There are two types of student loans: federal loans, which are sponsored by the government, and private student loans, which are, broadly speaking, from state-affiliated non-profits and schools. Prior to 2010 federal loans could be originated and held by private lenders, however this so-called guaranteed landing stopped in 2010 because it was believed that it boosted student lending companies profits but didn't lower students loan costs.
The CFPB notes a drop off in private student loans in 2011 as an argument that private lending is not working for student loan funding. Clearly, if you eliminate the primary path through which private lenders can participate in the student loan market of course you will see a decline in private student loans. The CFPB also claims that $8B/ $150B or 5.3% of student loans defaulted, while the CFPB uses this as an ominous number, in realty it is not too bad, when compared to default rates of small business loans. What I'm getting at here is this: while the CFPB makes it look like the banking industry does not want to participate in the student loan market, banks, in reality, have been limited in their ability to participate. The want to participate is not the problem.
In the late 2000s when some lenders were allowed to participate in the student loan market, an investigation uncovered that many universities unfairly steered student borrowers to "preferred lenders" and in return university financial aid staff received "kick backs." Limiting the market to a certain amount of lenders and leaving such a wide pool of supply to a small group of lenders allows for the opportunity for those lenders to unfairly take advantage of students, through universities.Many of the biggest offenders began as government sponsored agencies, which cemented their market share and allowed them to take further advantage of customers. Let's speak hypothetically for a moment. If we allow every bank to freely enter the student loan market, and originate student loans to whomever they want at whatever rate they felt was "fair". And if in this hypothetical we assume, as the general public actually does, that banks are experts at sniffing out profit and siphoning it away from the consumer, then with potential profits to be made, banks would fight over the interest rate margin until interest rates for student loans would reach a price range that the consumer feels is "fair". When it comes down to it aggressive price competition will always drive rates down to levels that are favorable to the consumer.
When it comes to regulation of banks regarding student loans, government's responsibilities should be two fold. First, they should monitor the relationship between the university and the banks to assure transparency and avoid any further scandals in favoritism between any single student lending institution and any single university. Second, and most important, they should focus on building a sustainable program to subsidize interest rates of student loans. Given the current trend of rising cost of education, the loan commitment amounts for student loans will also rise, and in turn, principal payments will have to rise because the term of student loans has already been stretched beyond its useful economic life. Government aid to offset the rising cost of education, and therefore the rising principal payment amounts on student loans, would be best served in the form of subsidized interest rates on student loans. Further analysis is needed, but if efforts are focused on a subsidy program that lowers borrowing costs for students by subsidizing banks' interest rate margins, student loans may garnish support from both the government and the banking industry. This, however, is only a short-term solution to offset rising costs of education. If this trend continues, it will only further evidence the need for a long-term solution to deal with the stagnant supply of higher-education institutions and the role of the financial industry in student lending.
In her article, my sister continues her justified criticism of the relationship between the banking industry and its consumers through the examination of the imbalance of power between the two, opening with a quote from Michael Foucault, "[Power] takes place when there is a relation between two free subjects, and this relation is unbalanced, so that one can act upon the other, and the other is acted upon, or allows himself to be acted upon."
The power of the consumer lies in the power of the masses. The banks need to be able to clearly hear the voice of the conglomeration to react appropriately; however, the consumers' message gets lost through the muffled game of telephone that is the government compliance and legislation of the banking industry.
In the relationship between banks and consumers, it can be said that the banks have the power because all rational consumers need a bank, while the banks do not need any one consumer. However, in the beginning of any single relationship between one consumer and one bank, the consumer has the power. The consumer has the choice to go to any bank they want. Although a poor credit score or insufficient income may stand in their way of one bank or another, the average consumer will have some choice to make in whom they will bank with.
It is the prospect of a long-term relationship and potential future business that gives the consumer leverage. Retail banking and depository relationships are generally not what drives the profitability of banks, but through these mechanisms banks can create relationships and provide their customers with other financial services that are of value to the consumer. This value is what generates a bank's profitability and it is only through maintaining a positive relationship with their consumers that a bank can accurately predict the likelihood that they will be reimbursed and successfully maintain profitability.
In this stage of the relationship the consumer can choose from a gamut of products and a wide range of banks to create a relationship that matches their needs: a 30-year, a 10-year, variable, fixed, option pricing, balloon payment, you name it banks are thinking of ways to package it. It is here where I believe the banking industry has made headway. All of these choices sprouted from consumer wants and evolved through open market forces between banks, their competitors and their consumers. Banks have made a concerted effort to improve the mediums of communication and meet consumers' needs. Through product segments such as mobile banking, the banking industry has been able to meet the consumer need for remote access to funds and improved integration of technology in business.
Once my sister, or a student like her, does get their student loan, the bank is out $170M in present time and will collect portions of that back over a long period of time along with a profit for providing the service of giving you money now for money later. What was it that Wimpy used to say? "I will gladly pay you Tuesday for a hamburger today." And not only that, the bank is going to expend time and resources to collect on that loan, to monitor that loan and mitigate as much risk as possible. While a bank is a place that holds and controls a lot of money it is neither a place that creates money nor is the money they have technically theirs. Writing off a $170M loss has the same impact on a bank as it does to a similar sized business being unable to collect a $170M receivable from one of their customers. As it is in the interest of the business for its customer's business to succeed in order to get paid back, it is in the best interest of the bank for my sister to succeed in her pursuit of higher education and obtain her highest future potential earnings.
While in my opinion consumers as a whole maintain power in their relationship with most of the banking industry, I do believe that there has been some damage to the mechanisms controlling the balance of power within the banking industry which has allowed for a concentration in a few "key" institutions that has begun to limit consumers' choices of where to bank. The banking industry is on the backend of some drastic changes in its landscape. According to the FDIC's Failed Bank List, from 2000-2006 there were 29 bank and thrift failures, from 2007-2013 there were 495. The good news is that that the failures have slowed down, the bad news is that the industry still needs time to let things settle before we can know for sure the direction in which things are heading.
When banks are forced into fighting over smaller and smaller interest rate margins, dealing with fluctuations in market-determined prime rates can put the entire banking system at risk. The government knows this and has passed legislation like "Too Big Too Fail" to purportedly protect the consumer by protecting banks that are vital to the banking industry. But, by doing so, the government puts an increased emphasis on a few financial institutions, concentrating power in the industry in the hands of those top players and shifting their overall power in the bank-consumer relationship. These banks, like Wells, Chase and BofA can more easily treat their customers on a transactional basis without having to worry as much about maintaining good relationships because their future business is guaranteed by government legislation. These financial institutions continue to feed the fire behind the negative connotation and stigma attached to the banking industry. Meanwhile the banking industry loses middle-market community banks, dispersing their distraught customers.
Banks may need to reevaluate their retail banking strategy for the future to meet consumer demands for a better relationship. One possible way for banks to do this is to address the relationship profitability on the retail side in a way similar to relationship profitability analysis done in commercial banking. While wealth management focuses on the banks relationship with mass affluent segment of retail, the vast majority of everyday customer relationships can go unnoticed. Perhaps through the use of statistics and data mining techniques, similar to sabermetrics in baseball, banks can find a way to better predict the future income of students, like my sister, and capture the potential profit that a long-term relationship with her would create. Like many romantic relationships, the key issues plaguing the bank-consumer relationship stem from poor communication. But there is hope. With potential profits out there and the entrepreneurial spirit to obtain them, the banking industry can overcome this negative stigma and mend this wounded relationship.