The recent unemployment claims have made it urgent for President Barack Obama to take congressional action on legislation so as to cut taxes and ease credit flow. The legislation that Obama wants to promote would ease loan terms and provide up to $12 billion in tax breaks to small businesses. Banks with $10 billion in assets will also receive $30 billion so as to encourage lending to small businesses.

The legislation is opposed by Republicans like Senator Richard Shelby of Alabama as he says that it is a government rescue measure similar to the $700 billion bank bailout of 2008. Banks may have to grant risky loans. Obama, however, urged Republicans to stop blocking the measure and prodded lawmakers to consider the bill when they reconvene in September.

The economic index of the Federal Reserve Bank of Philadelphia fell to minus 7.7 this month from 5.1 in July. The below zero reading indicates contraction in places like Pennsylvania, southern New Jersey and Delaware. Obama says “Small businesses and community banks that loan to small businesses have been lagging behind.” He adds that the report of Labor Department “compels us to act.”

During the congressional and state elections in November, ‘economy’ is going to be a top issue for voters. Obama said, “There will be plenty of time between now and November to play politics. Let’s put aside the partisanship for a while and work together.”

Obtaining a loan is no easy task. Banks check many aspects of a borrower’s history, such as previous bankruptcy filings, liens, or judgments. Previously, obtaining a $150,000 business loan just required a 700 FICO score and a one page application. The process of lending used to be transacted in the same amount of time required to buy a cheeseburger in a drive-through as well as only relying on borrowers’ personal credit scores. The unsecured nature of loans gave little recourse to lenders apart from the personal commitments and principles of borrowers. The personal guarantees become void when principles are broken. This is the reason why Kenneth Lewis, former chairman BOA, in 2008, commented on the banks’ deteriorating credit quality as “a dam disaster”.

Banks of today are still compensating for the blunders of such loans. This has made the process of obtaining a loan much stricter than before. The underwriting processes that work these days can be summarized as follows:

1. An assessment of character through personal credit report.
2. Borrowers’ basic character can be questioned with a skipped or missed student loan or child support payment.
3. Late payments of mandatory payments like mortgage, car, and credit-card payments are taken into consideration by lenders. Even one late payment is considered an indication of a possible beginning of risk.
4. The qualitative sections receive more attention. This includes payment history and public records data.

Importance of Credit Scores

The personal credit score of a borrower is analyzed to find out if the person fits into the general risk profile of the bank. It is assumed that there is a strong correlation between personal credit and the capability of businesses to pay back loans. Scores are also found in the business credit reports, but with the reliability of such as being more questionable than personal credit scores. The reason being that such scores are less reliable as they are made with the cooperation of business partners and often exclude information about prior bankruptcies, payment history and outstanding liens.

Personal credit scores do not affect one’s application but it determines the borrowing costs. Credit agencies like FICO, FICO II, or Beacon have their own methods of calculating credit scores and so it may vary up-to 50 points. Cost of capital increases if the score is below 700.

Income Proof Required

Borrowers wanting to obtain $50,000 in loans, have to verify their income first and provide details of three years of business and personal tax returns. Banks want the guarantee of the borrower’s personal resources in addition to financial pro formas and other personal guarantees. The size of the bank also determines the depth of investigation. A regional bank has a smaller buffer to overcome losses and so they have made deposit certificates compulsory. In case of nationalized banks, the protectionist stand may be far less.

The Federal Reserve Chairman, Ben S. Bernanke, expressed his solidarity for the Nation’s small businesses and urged banks and financial regulators to grant them loans for their success. Small businesses are responsible for 60% of job creation and employ almost half of all Americans. But the lending to small businesses show a decline in the last two years. Bernanke expressed his concerns and acknowledged the uncertainty in a daylong forum at the Fed’s headquarters.

Federal data reveals that lending fell below $670 billion in this year’s first quarter, a huge collapse, compared to $710 billion granted in second quarter of 2008. “How much of this reduction has been driven by weaker demand for loans from small businesses, how much by a deterioration in the financial condition of small businesses during the economic downturn, and how much by restricted credit availability?” Mr. Bernanke asked. “No doubt all three factors have played a role.”

A fall in the value of collateral and real estates that are used to secure loans is one reason for the decline. Borrowing based on personal credit cards and retirement accounts also posed problems. Even for businesses with strong cash flows but with depreciated value of collateral, obtaining credit for their expansion has become increasingly difficult.

Banks say that meritorious borrowers are granted loans and economists too agree that there is no evidence of refusal to lend. It’s only that banks have resorted to traditional underwriting standards after being too lax. Economists also argue that battered balance sheets and weak economic fundamentals have lowered new lending.

“Credit’s not an issue, Customers are the issue”, said William C. Dunkelberg, economist at Temple University. He reiterated that companies are still cutting on inventory and capital spending is at a 35 year low. But, Kevin P. Watters, chief executive at JP Morgan Chase, said banks are considering borrowers who were initially denied loans.

Citing new research, Bernanke said that in the last 20 years it has been seen that companies less than two old have generated a quarter of gross jobs in America which is certainly a reason to continue lending to small businesses in this recession.

The rules of Wall Street are being amended to better regulate the US financial System. Congress provided a rewrite of the rules that was submitted to President Obama on July 4th. After a 20 hour session of the House and Senate negotiators, a bill has been approved that envisages a ban on the bank’s proprietary trading and provides more oversight to the US financial market. The House and Senate are all set to vote on this measure and congressmen have conveyed that no further amendments will be added to the bill. Some of the major provisions that law makers in Washington agreed to in the Wall Street rules include the following:

Volcker Rule

Named after Paul Volcker, former Chairman of The Federal Reserve, the rule bans banks from proprietary trading. Banks can invest in private equity and hedge funds but are capped at 3% of the fund’s capital. For Tier 1 capital, the investment can be more than 3%. This is an amended provision from the bill introduced in May, when banks were completely barred from investing in hedge funds and private equities. This change was made in response to the Massachusetts Republican, Senator Scott Brown, whose concerns were that the ban would torment Boston-based State Street Corp. Brown along with three other republicans was the first to vote for the Senate bill, breaking party ranks. Proprietary trading is now defined as a principle for trading account of banks and financial institutions that are supervised by the Fed for purchase, sale or any other transactions. Any bans on proprietary trading actually reduce profits. Goldman Sachs says that 10 percent of its annual revenue comes from proprietary trading.

Derivatives

In a last minute deal, lawmakers for the first time introduced a regulatory structure for $615 trillion in the counter derivatives market. This provision will push banks to use some of their swap trading into subsidiaries. This will reduce the taxpayers’ risk by barring their trades from institutions that receive federal benefits. Senator Blanche Lincoln, chairman of the Senate Agriculture Committee actually introduced the original proposal to ban all swaps-trading by commercial banks. But, later there were negotiations among all parties, secretaries and directors whereby it was agreed that banks can maintain their trading operations until and unless they are used to trade interest rates or hedge risk or foreign exchange swaps. Now, federally insured banks will get two years time to clear un-cleared default swaps to separate capitalized subsidiary.

Consumer Bureau

A protection bureau at the Federal Reserve to police banks and financial services against abuse from credit-card and mortgage-lending, will be created. This plan is in opposition to the opinion of Republicans and financial industries. Obama proposed a stand-alone consumer agency to prevent financial crisis. Travis Plunkett, the Director at the Consumer Federation of America, said “It’s an agency with considerable authority to protect consumers from abusive financial practices, which is a landmark achievement.”

This bureau will be an independent authority though it will be housed at the Fed. It will be responsible to write consumer protection rules for banks and firms that offer financial services and will be headed by a director appointed by the president. It will enforce rules for firms with more than $10 billion in assets.

Credit, Debit cards

The Federal Reserve will have the authority to limit swipe fees during debit card transactions. Now retailers can refuse credit cards for less than $10 purchases. U.S. merchants pay interchange fees in Visa and MasterCard debit cards. Last year, the fees amounted to $19.7 billion and accounted to 1.63 percent on an average for each sale.

Oversight Council

It is meant to establish financial stability. The ‘Oversight Council’ will monitor large Wall Street firms and other real players and would respond to system risks. It will be headed by the treasury department. With 2/3 of the vote, the council can leverage capital requirements on lenders and bring hedge funds and broker dealers under the Fed’s authority. It will also have the power to force companies to divest their holdings if they become a threat for the financial stability of the country.

Bank Capital Rules

Introduced by Senator Susan Collins, the bill will force some banks to show their capital. It is going to show its impact on ‘Trust Preferred Securities’ (TruPS). Banks with $15 billion in assets will find 5 years time to replace TruPS with common stock and other securities. It is found that smaller lenders sold $45 billion in TruPS out of the $150 billion issued by US banks. According to Richard Bove, analyst at Rochdale Securities, smaller banks like McLean, Capital One Financial Corp. & Buffalo and M&T Bank Corp would be hurt the most as they heavily rely on TruPS.

The Federal Reserve

The Federal Reserve will possess a broad supervisory scope and will bring transparency to its 96 year history. Headed by Chairman Ben S. Bernanke, a new Financial Stability Oversight Council will be created that will deputize the Fed to implement tough standards for disclosure, capital and liquidity. The rules will be the same for all financial companies and banks that pose a financial system risk. The Fed’s bank supervision was earlier curtailed but now the bill would allow the Fed to keep supervising banks like Goldman Sachs, Bank of America and Central Virginia Bank shares Inc, which have assets around $471 million.

There are also other provisions under this bill that enforces amendments in segments such as Credit Raters, Private Equity, Failed Firms, Risk Retention, Fiduciary Duty and the Insurance Industry. The changes have helped to regulate discrepancies in the US financial system with concessions granted to taxpayers and banks.

The conviction that the ‘trade creditor’ would come to the rescue and fund businesses may no longer be the case. Trade creditors are now scrutinizing their credit applicants. While banks just make up about 20% of the short term credit for small businesses, the other suppliers make up the rest (surveyed by Credit Research Foundation, a trade group in Columbia, MD). But with banks showing more friction towards lending, small companies have their eyes fixed on private creditors for loans. They are also pressing vendors for more time to make their bill payments and also asking for loans so that they can keep afloat until they receive payments from their clients.

“Small businesses have been forced to reach out to trade creditors and begin to utilize them as bankers,” says Lyle P. Wallis, vice-president, Credit Research Foundation. But the real difficulty arises with trade creditors slashing their loan amounts to borrowers. A microscopic analysis of creditors is being done by vendors before lending out loans to their customers. Gray Desilets, who runs a $2 million construction business witnessed a slash of credit line from $200,000 to $20,000 from the company that sells him building materials and $20,000 to $8,000 from Home Depot. Trade-creditors have increased their use of scoring tools as well. Products like ‘Dun & Bradstreet’s’ credit reports and ‘Experian’s Predictive Metrics’ have seen client inquiries triple in the last three years.

Earlier, it was possible for small business owners to work out a deal with suppliers that enabled them to clear their debts slowly. But now such negotiations are long gone, as trade creditors are taking steps to cut off customers who are less likely to pay bills. Trade creditors do however fear that by doing so, they might completely lose their customers. As Rob Olsen, chief risk officer at WXS, says “Trade creditors have to step in or they lose the sale.”

If banks weren’t in enough trouble, there’s another threat on the horizon. Wal-Mart is encroaching on the banking industry by providing more financial services to its millions of customers.

The giant retailer has partnered with other companies to offer consumers money transfers, check cashing and bill payment services, and virtual checking accounts in the form of refillable, pre-paid debit cards, said CNN.com.

Wal-Mart has tried several times in the past to acquire its own banking license but failed. Now Wal-Mart is seeking regulatory approval to acquire a small Utah-based bank for $15.7 million, according to CNN.com.

Last week the company opened its 1,000th “Money Center” and has plans to open 500 more. Wal-Mart has operated a bank in Mexico since 2007. After receiving a banking license in Canda last month, the company has rolled out a new Wal-Mart credit card.

In addition to making money on banking fees, Wal-Mart encourages customers to shop at the store by offering cash-back incentives and other deals.

The company believes it can provide alternative banking services to at least 25 percent of the U.S. population, noting that 28 million people in the country don’t have a bank account.

“Wal-Mart is going to accelerate the evolution of the banking industry,” Anthony Plath, a finance professor at the University of North Carolina, told CNN.  “They would be a different kind of bank, but the kind of bank the industry may need right now.”

New data shows the recession is far from over, especially for the nation’s banks.

In the first quarter of 2009, six out of every 10 banks in the U.S. were less well prepared to withstand possible loan losses than they had been at the end of 2008, according to a new analysis by msnbc.com and the Investigative Reporting Workshop at American University in Washington.

Overall, bad real estate loans rose another 22 percent in the quarter, according to the report.

The country’s 10 largest banks made $10.2 billion — the vast majority of reported bank earnings this quarter. The more than 8,000 remaining banks lost $2.6 billion, according to the analysis.

You can get information about more than 8,000 of the country’s banks at Banktracker.investigativereportingworkshop.org.