Small business lending: Can you compete?
A small business owner doesn’t want to wait weeks for a decision—and today, they know they don’t have to.
When it comes to securing a loan, small businesses today claim no shortage of options. And the proliferation of online and marketplace lenders has led to a significant result: Many bankers now question their competitive posture.
Leading marketplace lenders originated about $1.9 billion in small business loans last year. That’s up nearly 60 percent from 2014, according to a Treasury Department study as reported by the Wall Street Journal in June 2016. Yet the influx of new players has changed the game. Bankers realize that to stay competitive—and not just viable—they must truly understand what small businesses really need from a lender. Yet it’s not all about interest rate numbers, but increasingly a chronological one: speed.
Small business owners, for example, are not about an attractive rate far above all criteria. In fact, rate is rarely a sticking point if a lender can turn around a fast decision. This is where many banks struggle to win against non-bank contenders. But this doesn’t have to be the case. With a renewed focus on the distinct needs of small businesses—in tandem with the right technology—banks can achieve both the speed and profitability they need to compete.
Differentiating Small Businesses
As banks prioritize small business lending, they will need a firm understanding of how to accommodate the nuances of this customer segment. Far too often, banks continue to repurpose their commercial lending technology and processes for small business loans. But that’s a mistake. It is critical to develop a product set specifically to support this client base.
Small business simply don’t demand the customization commercial loans require, so using a more complex process can considerably delay small business loan decision making—and that puts banks at a strategic disadvantage. Instead, bankers should develop dedicated small business products that streamline processes by aligning with the simplified requirements of these loans. (For example, small business product sets should abridge the application process by requiring limited information yet remain in accordance with a bank’s policies.)
The stakes are high: If banks continue to use commercial systems for small business lending, it will be difficult to generate the efficiencies required to make fast decisions and compete with the alternative lenders.
Banks should also keep in mind that unlike commercial customers, small business owners traditionally visit the bank branch personally or manage their banking online. They are not accustomed to working through the corporate office, so it’s important for banks to structure their branch networks accordingly. Branch managers and/or small business lending specialists will find it valuable to manage the day-to-day relationships with small businesses customers—to provide the service they need in an environment where they are already comfortable managing their banking needs.
Seeing the Whole Picture
In addition to employing separate product sets for small business loans, banks must also evaluate their existing underwriting practices. Looking at just a small business owner’s business account doesn’t provide the whole picture. Rather, banks should view an owner’s personal and business accounts during the decisioning process. This provides a more comprehensive view of several factors—such as whether the individual is carrying the debt, the business or a combination. Others might include whether a business owner seeks a personal loan, but is putting money toward the business, or borrows for the business, yet needs the money personally.
These circumstances and considerations—common in the small business lending environment—require a vastly different approach to analysis and underwriting. Whether a bank uses a scoring model (blending personal and business accounts) or traditional analyses (based on the borrowers’ global cash flow) it must be equipped to evaluate small business owners’ personal and business accounts together.
Scoring should also make up an integral part of the small business lending process for efficiency and profitability purposes. Lower dollar loans with smaller profit margins require banks to realize the utmost efficiency to help drive down costs. In short: Banks simply cannot underwrite a $100,000 loan the same way as a $2 million commercial loan because the money to support the costs just isn’t there. From an underwriting perspective, modified scoring techniques that provide full visibility empower a bank to deliver a stronger loan product faster.
Eliminating Data Silos
A holistic approach to small business lending can boil down to a data access challenge. Often, the data that banks need to make fast, sound lending decisions is housed in separate repositories and spreadsheets—and that makes it extremely difficult to access and evaluate.
This fragmentation, created by organizational silos, hinders small business lending initiatives and productivity. If bankers can’t gain an in-depth look into a borrower’s finances—quickly and easily—they’ll fail to truly see what their small business customers need. To make wise lending decisions that best serve small businesses, a bank must understand the needs of every small business it serves. To that end, data plays a crucial role.
This means accessing beyond the owner’s personal and business loan relationships: Banks should be able to quickly assess deposit relationships, too. By eliminating that isolated perspective, banks can more successfully cross sell and promote stronger overall relationships.
More Loans Doesn’t Mean More Risk
Any bank looking to grow its small business loan portfolio wants to do so without incurring added risk. Yet an outdated practice persists throughout our industry: Many banks collect and organize data manually, filtering through reports to spot trends. In relying on this practice, portfolio monitoring can only realistically occur irregularly or on an annual basis at best—forcing banks to take a reactive approach to risk management.
As a result, bankers then have no consistent, accurate way to identify negative symptoms of a problem before an issue occurs; they will inevitably overlook both vulnerabilities and opportunities. This is where a major shift needs to occur.
Portfolio monitoring cannot occur just once or a few times a year: It must become an ongoing process. Technology-driven risk management lets banks proactively alleviate risk and contribute to the process efficiencies needed in a successful small business lending environment.
So banks can compete with alternative lenders, if they enact the following:
- Deploy specialized products
- Avoid treating small business loans like commercial loans
- Consider whether they will modify their policies and processes—and are willing to price differently to take on additional risk
- Prioritize a fast decision over an attractive rate
These changes are essential to making small business lending efforts profitable. Today’s forward-thinking banks are not looking at online lenders as having methods they must match. In the end, banks must understand what they must do to better serve the small business community, while upholding prudent best practices on the way to long-term success.
Naseer Nasim, CEO of Baker Hill, is recognized as one of the leading technology executives in the financial software and solutions industry.