In periods of uncertainty, the only certainty is that risk increases. In statistical analysis risk is defined by a growing variance level. The wider the swings recorded between a bottom and top boundary determines the risk level. Recently, we have all watched the stock market vary widely on a daily and week-to-week basis. Part of the fluctuations have been caused by the talk of and decisions made regarding international trade tariffs. Understanding how the current policy movements surrounding the tariffs affect your bank is critical right now.
Tariffs 101: What they really mean
There has been quite a bit of opinion on what rising tariffs mean and how they might work. Most of it is bunk from sources that never took an economics course. Prior to discussing how the tariffs could impact the banking system, let’s hit some basics on tariffs.
By implementing tariffs, one nation is attempting to protect its production industries from another country. Most of the time there is a large imbalance in labor pricing or in the exporting countries financial support for its own industry. This leads to an under-market price of the goods sold producing purchases of imports at the expense of the domestic industry under attack. By placing tariffs on the imports, a balancing of the playing field is sought.
Inflation, shortages, or status quo?
Economically there are a few outcomes that occur. The exporting country picks up the tariff payment to maintain the level of trade. The tariff income is then used to support the target industries to offset the continued loss of sales to cheaper suppliers. In this case no inflation occurs in the importing country. If the tariff is excessive, the goods to be exported are held back and the importing country goes without, again no inflation occurs, but shortages will arise. In regard to items of necessity, the importing firms will pay the cost, raise the price and the consumers will decide to buy or forego the purchase. Inflation would indeed occur at this point.
Credit policy in the crosshairs
So how does this all impact your bank? The answer goes to the credit priorities that you as a board and ownership have set for your bank. The decision on the level of credit risk that you have decided to accept along with the front-end guidance that you have approved in your credit policy is crucial.
Within your credit portfolio, the exposure related to Commercial & Industrial as well as distribution/wholesale firms should be looked at. While protecting and expanding our manufacturing industries is the goal of the current tariff fight, the outcome could be crippling our local firms. If the production of a final good relies on an imported part from a tariff-targeted country, our borrowers could be dead in the water. They may not be able to source the parts needed or if they do, the cost is so high that the end product is too expensive to sell. This is a time for your bankers to meet with their manufacturing clients to fully understand which direction the tariffs may take them, more sales, higher profit margins, or temporary furloughs.
Opportunities—and limits—for growth
There could be an opportunity for your bank if your clients are looking to on-shore production of items impacted by the tariffs. However, until we know that the tariffs are going to be in place permanently, it is likely premature to provide financing in all but the sure cinch deals.
Depending on what types of products our distributors market, they could be in fat city or in a world of hurt. Any firm selling imported, finished products are already experiencing shortages. Again, your bankers need to be making on site visits, talking to the client and getting feedback so they can assist in solving their problem.
Your role as a trusted advisor
To be clear, solving their problem does not mean providing them with more financing. By being a trusted advisor, we are there to provide solutions by assisting them in thinking outside the box.
The rest of this year will determine what impact the tariffs will have on our economy and our banks. The key is to work with our clients as they also navigate troubled waters to find the right solution, not the most expedient one.
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