To Loan or Not to Loan?
Harry Edwards is the loan officer at High Plains Bank, a small bank located in a town of 3,000 people in rural Oklahoma. High Plains, like many other small financial institutions, makes most of its loans to small businesses and engages in relational banking. In relational banking, bank officials focus on establishing close relationships with customers. Relational banking allows loan officers to get to know their customers better to determine if they are good credit risks. (Small businesses are not required to have audited financial statements.) Customers benefit because the trusting relationships they develop with their bankers allows them more flexibility in negotiating their loan terms. The community benefits as the flow of capital keeps businesses open. However, relational banking can pose a risk to small institutions because it encourages bank officers to make bad loans to those they have befriended.
Edwards is scheduled to meet with the bank president and vice-president to evaluate the High Plains' loan portfolio, which has not performed well lately. The Highway Market loan will be the main topic of discussion. Highway Market borrowed $300,000 to upgrade its store, replacing the flooring and roof, adding a new bakery and deli department, replacing freezers, creating wider aisles, and so on. However, market owners Bert and Samantha Smith have fallen behind in their loan payments and need another $100,000 to finish the renovation project. They have asked High Plains for the additional amount. The Smiths are long-time customers of the bank and have never fallen behind in their payments before. Edwards, the bank president, and vice-president all serve on community nonprofit boards with the Smiths. In paperwork submitted to High Plains, the Smiths blame their delinquent loan payments on the fact that the disruption caused by the remodel has reduced traffic to their store. They are convinced that the renovation will more than pay for itself in higher sales when completed. While Highway Market is the only grocery store in town (and badly needs the upgrade), Harry knows that a new Wal-Mart superstore featuring low prices is coming to another small community 15 miles away. He anticipates that residents of his town will spend some of their grocery budgets at Wal-Mart after it opens in two months.
The question I need answered is:
Should Harry Edwards recommend that the bank loan another $100,000 to Highway Market? Why or why not?