The Economy

Guns and Money: When Banks Apply Moral Standards

GE Capital’s decision to stop financing gun-shop purchases is not the only instance of a lender adhering to its sense of “right and wrong” when scr...

A legal business getting blacklisted by a bank? It may not be as far-fetched as it sounds. Whether because of heightened social consciousness of a certain industry’s activities or a misguided ethical decision by a bank’s management team, a source of capital for some kinds of business borrowers has been cut off.

It’s the rare case that comes to light: last week, GE Capital shut off a lending program that financed consumer firearms purchases at gun shops, citing as part of that decision “new legislation and tragic events that have caused widespread reexamination of politics on firearms.”

With its decision, GE Capital waded into the dangerous political debate over gun control and risked a customer backlash in some parts of the United States. But financial institutions have always had policies about refusing loans to not only illegal businesses but also to those that clash with their corporate values, say bankers and consultants. Five years ago, China’s central bank ordered domestic banks to stop lending to projects that caused heavy pollution or wasted energy.

In the United States, some banks have written policies prohibiting loans to casinos or other gambling- industry businesses. Others refuse loans to companies involved in the pornography business. And most banks would have an implicit policy of not lending to businesses that they think are overtly or even in a veiled way tied to prostitution, like escort services, says Shaheen Dil, a managing director in the risk and compliance practice of Protiviti.

Applying moral values to underwriting is not new.

“Any organization should have a moral compass,” says Mariner Kemper, CEO of UMB Financial, a $15 billion Kansas City-based bank. “If GE doesn’t want to lend to gun shops, great, that’s an opportunity for another lender to fill that void. That’s who we are in America.”

But is “ethical underwriting” and the choices it poses becoming more of a risk for banks, and hence, their borrowers? For example, Kemper pointed to a more recent problem banks are running up against: when they buy other banks’ loan portfolios, sometimes there are existing loans to medical marijuana shops.  How to proceed in this situation is a hot topic among bankers, says Kemper, because medical marijuana is legal in some states but illegal at the federal level. “A bank will inherit a loan to a CBD business, and the bank has to go to their legal and compliance groups and figure out whether they can renew the loan,” he says.

Also causing the problem to surface is a national divisiveness over such social issues. “You’ve got a group of people much more accepting [of] divergent views. But on the other hand anything out of the norm really does become heavily polarized,” says Gary Young, CEO of Young & Associates, a risk management consultant for banks.

For banks, it’s clearly a complex reputational risk. They have to be cautious about lending to a morally questionable business, but it’s also risky to refuse to lend to a legal business or blackball an entire industry, Young says. The charter of a bank “is not to [t]ake a moral stand; it’s to make loans based on the [economic circumstances] and the ability of the person to pay back the debt,” he says.

Any moral judgment has to be very clear-cut, says Young. Otherwise. management could be heading down a slippery slope.

For example, a bank could say it doesn’t want to lend to adult night clubs, and its employees and customers would most likely understand that, Young says. Gun shops are less clear-cut — in some parts of the United States that would be viewed negatively. (At the same time, if an industry’s viability is threatened by potential government regulation or legislation, that’s a legitimate part of a bank’s credit risk assessment, he points out.)

But a bank’s management can stray too far and end up actually discriminating. “Many people in this country would have no problem lending for the establishment of a Protestant church or a Jewish synagogue, but some might raise questions if an organization was borrowing to build a mosque,” Young says. “I don’t think [they] should question it.”

Of course, the United States has fair-lending laws that prohibit discriminating against consumers based on race, color, religion, national origin, sex, handicap or familial status. Fair lending can also apply to businesses – like a minority owned company, points out Dil.

Most banks are rigorous about making sure that they don’t violate fair-lending rules. Technology makes compliance easier, says Dil. Compared with  20 years ago, credit-portfolio management systems are much more sophisticated, says Dil, a former banker. They enable bankers to dig into a database of loans classified by industry, not just location. Even regional banks have credit-portfolio- management databases that let them search by type of business or Standard Industrial Classification code, Dil says.

Although big banks may have better systems, morally questionable businesses might actually have a better chance of getting a loan at a big bank, says Dil. A global bank with trillions of dollars in assets, for example, would have trouble applying a universal policy based on corporate values. “A bank operating in the United States and the Netherlands, where prostitution is perfectly legal, could not have a policy on its books that prohibits lending to those businesses nor apply that globally,” Dil says.

Smaller, community-based institutions are more likely to adhere to a moral compass. “It’s really about our obligation to help grow the communities we are in,” says Michael Hagedorn, UMB Financial’s CFO. “Within the risk profile of the institution we do take this seriously. We have a moral obligation to invest in things that grow our communities.”

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