Top 10 Reasons Banks Need to Charge More

Why it’s time to price banking services by factoring in externalities

Banks are propping up bad businesses with good capital

Definition of a bad business

The term “bad business” is being used in this whitepaper to describe a company with negative externalities that can be avoided but are present in the company's business by choice, poor decision making, undue pressure or negligence.

Definition of good capital

Good capital is being used here to describe market competitive cost of capital, typically provided to businesses with a low credit risk score to mitigate instances of repayment failure.

The outcome

By offering market competitive costs of capital to a bad acting company, banks are funding an increase in negative externalities affecting their own portfolios, environmental surroundings, health & wellbeing.

Banks are putting their own portfolio companies at risk

Everything is connected

There’s a direct correlation between corporations that produce negative externalities and those companies that are negatively affected by them. It’s cause and effect. This is evident when discussed but not taken into account when banks are performing underwriting and determining the cost of capital for corporations. Today banks price capital and services as if their portfolio companies are siloed. Obviously, this isn’t true. Each portfolio company can negatively or positively affect the other by their normal course of business and the externalities they produce.

Real world case studies

As this whitepaper was being written, The Coca-Cola Company earned the dishonor of taking the crown as the worst plastic polluter of 2020.

Plastic pollution costs $13 billion in economic damage to marine ecosystems per year

This includes losses to the fishing industry and tourism, as well as the cost to clean up beaches. The tourism industry comprises transportation, accommodation, food & beverage, recreation & entertainment, and travel services. To cherry pick a few examples from these categories, that means The Coca-Cola Company, through its normal course of business, has a negative impact on:

• Airline Industry, e.g American Airlines, Delta Airlines
• Car Rental, e.g. Hertz, Alamo
• Cruise Liners, e.g. Royal Caribbean, Norweigan, Carnival
• Hotel Industry, e.g. Marriott, Hilton
• Restaurants, e.g. Starbucks, McDonald's, Yum Brands
• Travel Services e.g. Expedia, American Express Travel

Is this factored in by banks who are pricing capital for The Coca-Cola Company? No. That becomes even more risky when the same bank that is extending capital to Coca-Cola for expansion etc, is also extending capital to American Airlines, for example.

Banks are funding environmental destruction

Externalities hold the key

An externality is a side effect or consequence of an industrial or commercial activity that affects other parties without this being reflected in the cost of the goods or services involved. With the Coca Cola example, an excess production of plastic that subsequently results in pollution is an externality of their core business, producing bottled drinks for consumption.

BlackRock, the world's largest asset manager, says that it will now make climate change central to its investment considerations. And not just for environmental reasons — but because it believes that climate change is reshaping the world's financial system.

This is a major shift in the right direction. But what about banks? The case we are making here is that banks are best positioned to prevent negative externalities much earlier in the life cycle of destruction.

Banks are funding companies that create a burden for taxpayers

Corporate Welfare (part 1)

By not paying employees a living wage, corporations place the burden of basic living expenses for these employees, to the taxpayer. These employees are forced to turn to federal assistance programs to provide basic necessities.

A recent report highlighted Walmart and McDonalds as having the most workers on these programs.

Walmart was one of the top four employers of SNAP and Medicaid beneficiaries in every state. McDonald’s was in the top five of employers with employees receiving federal benefits in at least nine states. By not taking this into account when pricing banking services and capital to a corporation, Banks are funding the continuation of this behaviour and placing a burden on governments and taxpayers. This is called Corporate Welfare.

The outcome

By offering market competitive costs of capital to a bad acting company, banks are funding an increase in negative externalities affecting their own portfolios, environmental surroundings, health and wellbeing.

Banks are funding companies that create stress for healthcare systems

Corporate Welfare (part 2)

When a Walmart employee is not provided health insurance, they turn to government assistance, or perhaps wind up using emergency rooms for primary care.

The Government Accountability Office (GAO) study found that of the 12 million wage-earning adults (ages 19 to 64) enrolled in Medicaid 70 percent worked full-time hours (i.e., 35 hours or more) on a weekly basis and about one-half of them worked full-time hours annually.

These are full-time employees that are not provided health insurance, so that a corporation can lower costs. The burden of those costs are simply shifted to the taxpayer.

Banks are not taking into account externalities when pricing capital

Banks are looking at traditional metrics when performing underwriting and evaluating credit risk. Those metrics boil down to the “Five C’s”:

• The first C is character—reflected by the applicant's credit history
• The second C is capacity—the applicant's debt-to-income ratio
• The third C is capital—the amount of money an applicant has
• The fourth C is collateral—an asset that can back or act as security for the loan
• The fifth C is conditions—the purpose of the loan, the amount involved, and prevailing interest rates

That’s it. Banks are looking at these metrics to determine credit risk. Banks are not looking at the externalities of a corporation to determine:

• Does this corporation negatively affect other portfolio companies?
• Does this corporation maintain business practices that are harmful to the environment?
• Does this corporation underpay employees thereby creating a burden for taxpayers?

If they did, they could prevent harmful & destructive corporate behavior and de risk their own portfolio.

Banks are being short-sighted when evaluating credit worthiness

As highlighted in this whitepaper, the “5 C’s” of corporate underwriting is limited to traditional financial metrics to avoid credit exposure & risk. This approach does not take into account all of the variables, including externalities that make up the big picture of a corporation, how they affect other portfolio companies, the environment and society. When looked at through this lens, a different picture emerges, one that is more holistic, beneficial to the economy, society and the banks own portfolio. What is being proposed in this whitepaper is a Future Focused view of a corporation that measures, calculates and ultimately determines how a corporation scores in two main categories:

• Human
• Environmental

By doing so, Banks can play a major role in shaping corporate behavior.

Banks are positioned to accelerate positive change in business practices

• Access to affordable capital is key for growth
• Banks can stipulate Future Focused metrics as requirements
• Corporations can have improvements certified for better pricing

Capital is the lifeblood of any corporation. Capital is required for startup, growth and scale. Large and small corporations share this need and banks are the primary provider of capital for business, outside of private investment. By setting new standards, factoring in Human and Environmental externalities, banks can accelerate positive change by pressing on two key drivers:

Fear & Greed

Fear will ensure a corporation scores highly under this new proposed underwriting model, else they cannot obtain the capital their business needs.
Greed will drive corporate behavior to score highly under this new proposed underwriting model for inclusion in new financial instruments as we see today with “Green ETFs”

Banks can price capital taking into account current & future business practices

• Banks can offer adjustable rates affected by Future Focused metrics
• Rates can auto adjust based on Future Focused algorithms

Change takes time. What is being proposed in this whitepaper is an agile, real-time system of underwriting taking into account Human & Environmental externalities. Corporates can be scored based on publicly available information, gleaned from a multitude of sources, then provided a roadmap for improvement and a deeper auditing process to provide proof of improvements. This provides a framework for current & future state and this is factored into the cost of capital a corporation receives as well as access to certain banking products.

By pricing banking services according to externalities, Banks can reward businesses with positive impacts and discourage negative behavior

In closing, a FutureFocused system of underwriting is being proposed, one that takes a big picture view of a corporation, factors in Human & Environmental externalities, bounces those externalities against existing portfolios to determine the true credit risk of a corporation.

• De-risk portfolios
• Incentive Future Focused corporations
• Disincentivize harmful business practices

Let's get Back to the Future

Future Focused’s data collection service scours hundreds of data sources, searching News, Social Media, Market Data, Filings and much more to compile a real-time Future Focused heartbeat on corporations. This produces a FutureFocused "soft score" and becomes a starting point for pricing capital.