1. The Fed is paying 95% of the loan, so why would the banks be scared of lending?

  2. Even if the bank loses their 5% because they partaked in Fed's Main Street Lending Program, can't the Federal Reserve or US Treasury can bail out and rescue the bank?

The Trump Administration Says a New Bailout Program Will Help 35 Million Americans. It Probably Won’t. — ProPublica

Banks Might Not Lend

Another problem is the mechanism by which the program will be implemented: through banks.

The Federal Reserve doesn’t normally lend to nonfinancial companies. So, as with the Paycheck Protection Program, banks will take on the responsibility of studying the finances and prospects of each business that wants a Main Street loan and decide whether to approve it.

To protect taxpayers and incentivize the banks to make good loans, the program requires banks to keep between 5% and 15% of the debt — and thus a portion of the risk — on their own books. But that clause also deter banks from participating.

Putting their own money on the line could be an obstacle, said Christy Hester, director of growth and development at the Independent Bankers Association of Texas. “It means they’ve got accounting and reporting requirements,” she said. “Just setting up the accounting side of that and the servicing side of that, if it’s not already set up, that’s a pretty big burden for a small community bank.”

The Small Business Administration, which is administering the lending program, has said it will disclose the names of companies that got loans — just not yet. News organizations are suing to stop the delay.

The Main Street program compensates banks by allowing them to charge an origination fee of up to 1% of the loan, plus an annual servicing fee. Because it’s so difficult to assess the risk of lending money in the climate of pandemic-induced uncertainty, that might not be enough.

It’s not surprising that banks would prefer to receive higher fees and take on less risk. But it does mean that running the program through the banks could slow things down.

What Is the Federal Reserve Main Street Lending Program? - SmartAsset

More specifically, once your company gets its loan, the Federal Reserve will buy up 95% of the loan from the bank, leaving just 5% with the bank that originated the loan. The term of these loans is four years, and amounts generally range between \$1 million and \$25 million. These loans cannot be used to pay off any other existing debt the borrower has.

The Federal Reserve will be purchasing up to \$600 billion in loans.

  • $\begingroup$ This is a good question. Maybe banks are already too busy at the moment dealing with existing loans? The Fed has already provided ample liquidity using its existing toolbox. The problem is that banks are still unwilling to take on risk, for good reason. Maybe the Fed should set it up in such a way that the bank gets paid 20% interest on its portion, while the Fed gets paid 1% interest on its portion? $\endgroup$ Jun 14 '20 at 20:28

I saw these two answers on Reddit or Quora, but I can't find them now. Just edit this if you do.

Because the potential losses are much bigger than 5% if you read the program. Consider the pari passu clause. In a liquidation, what's the collateral that the Main Street loan has a claim to? Collateral that is securing any existing loans you’ve granted! Thus your loss can easily outstrip the 5%, as it eats into existing collateral and increases a bank's deficiency.

Even if the bank just loses 5%, the people needing this money are going to be very risky and banks can focus their time and efforts on way less riskier programs. Contrary to popular belief, a bank doesn’t just magically get bailed out with zero pain anytime they lose some money. It’s still a 5% loss which on loans of this size are significant once they get added up. Moneys have much less risky and better ways to sell their money right now.

That is why the loan program should have been more like FAFSA that use IRS data to verify businesses and grant them an amount. FAFSA get to pick a bank to service or another servicer. This is how the student loan program works. If the loans were based on credit alone then no one would get them. Doing this through the banks was a horrible idea. If you grant businesses an amount, then they are the customer that chooses the bank that gets the servicer fees as the loans are guaranteed. Not the other way around where banks are the gatekeeper to this money.

It is amazing how bad banks screwed up in the last bailout which they used just for themselves and to shore up capitalization/leverage. We were stupid to trust the banks this time ago, and by design are helping larger companies by the cronies.

The market is efficient. You have to set the right incentives and targets though.

Banks are in self-preservation mode. If they were cut out and had to go court customers with free money in guaranteed loans with windfall service fees from the bailout they would, though since we let banks be the gatekeepers to survival again they get to keep free money and they will cut risk.


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