You could mark a loan to market, or book it at amortized cost. But either way, the loan's real value might not get fully captured.
With the emphasis in banking turning from credit costs to cross-selling, bankers are less interested in lending than in building relationships. And they are willing to use commercial and corporate loans to attract deposits from borrowers, or to generate revenue in other parts of the business by offering trust, treasury, wealth management or capital markets services alongside the credit.
That carrot-and-stick approach is one of the reasons Goldman Sachs Group Inc. says it is in favor of a proposal to expand the use of mark-to-market accounting, which would force banks to recognize that they sometimes extend credit at below-market rates in order to win underwriting business from clients.
When banks do that, there can be "a significant difference between the contract price and the fair value" of the loan, Goldman argued in a letter to the Financial Accounting Standards Board commenting on its fair-value proposal.
At first blush, the "lend to play" practice Goldman cited sounds like shady dealing — if not a call for the reinstatement of the Glass-Steagall Act. But is it really so unsavory or unusual for bankers to think about the price of credit in a broader context? Is there a banker alive who hasn't given a little bit on a loan to get the client on board with other services offered by the bank, or to preserve a long-term relationship with a customer threatening to walk, or to beat the competing lender on the other side of the street?
"If bankers had their perfect world, every loan they made would pay for itself and they'd get the other business they'd hoped for," said David Gibbons, a managing director at Promontory Financial Group who advises financial services firms in areas including credit due diligence and risk-management evaluation.
Instead, banks sometimes steal a page from other industries that have made a science out of using loss leaders to drive business. King Gillette knew he could sell razors cheaply and reap profits on the sales of blades. Supermarkets know that they can increase foot traffic and direct it past all kinds of high-margin items in the aisles, by slashing prices on eggs or milk or Thanksgiving turkeys.
The trick is selling enough razor blades or groceries — or trust accounts or cash-management mandates — to make the loss leader worthwhile. And in banking, even just ascertaining whether a relationship is panning out as profitably as expected can be an inexact science.
"Banks tend not to have the infrastructure from an analytics perspective or a technology perspective to be able to answer that question retrospectively, and that is a big thing they are trying to overcome," said Shahram "Rami" Elghanayan, a managing director of risk consulting for SunGard Data Systems Inc.
And though loan growth might not be strong enough right now to justify big investments to help with origination work, with loan renewal season right around the corner there is still plenty of interest on the part of banks in tools that can help them evaluate their relationships with clients.
"As soon as those end-of-year financials come in and people are reviewing their customers, they'll be asking, 'What can I do to improve the profitability of these customers from a relationship perspective?' " Elghanayan said.
It's a vital question, considering that upwards of 140% of a bank’s profits can come from 20% of its customers, he added. The balance of clients are not generating the revenue needed to cover the cost of their relationship, which means the bank is not getting compensated enough for the expected losses, capital charges, taxes, interest expenses and non-interest expenses it is taking on when it extends a loan.
Regulators, while sympathetic to the idea that a loan can be just one piece of a broader relationship, also are looking for assurances that banks have the systems to track the risks and rewards built into their dealings with customers, said Promontory's Gibbons, a former bank supervisor with the Office of the Comptroller of the Currency.
"If a bank had a track record of using loans as loss-leaders and never getting other business out of it, and the regulators could see that returns were not materializing, they would clamp down on it," Gibbons said.
Given the tightening of credit standards since the financial crisis hit, banks theoretically have more bargaining chips to maximize the scope of their relationships with borrowers.
But lending demand remains weak, which puts at least some of the negotiating power back in the hands of customers.
"If you look over the past 20 or 30 years, there have been few periods of time where the banks had the power, where their competitive desire to grow was overtaken by their conservatism," said Rob Friedman, who leads Deloitte's bank pricing and profitability management practice.
The same competitive instincts drive the "lend to play" scenario described by Goldman in its letter to the FASB.
The public comment period on the FASB's proposal ends Sept. 30.
After that it is up to the accountants to figure out how the value of loans should be measured — but still up to bankers to figure out how the value of loans can be maximized.