There are 28 million small businesses in the United States.
Let’s take a closer look at that number: It comes to one business for every 11 or 12 people in the U.S. Clearly, this market is ripe with opportunity. And yet, reasons abound as to why banks haven’t fulfilled small business loan requests.
For starters, small business loans have traditionally been unprofitable and somewhat inefficient for banks, and thus present something of a challenge. For while small businesses typically uphold some degree of loyalty to their primary financial institution, Aite Group has found that these credit seekers simply don’t borrow from banks the way they once did—or when they do borrow, they’re patient enough to comparison shop and apply early and often for loans.
Yet for banks, continual optimization is necessary. Quality and speed must align—not compete with each other. And banks must rely on these principles as they work to retain, and earn back, their small business loan relationships.
Historically, credits less than $250,000 haven’t delivered significant economic impact to a bank’s bottom line. In fact, fulfilling these smaller credits tend to take just as much effort to fulfill as a $2 million dollar loan, and with less economic benefit.
And because banks emphasize creditworthiness, expanding into this market is difficult. Further, the loan process remains inherently inefficient and paper-heavy; it costs excessive time and resources for banks to move a loan through application to funding.
Alternative lenders’ need for amends
Where banks have stumbled, alternative lenders have rushed in to fill the void with their promise of instant decisions and fast funds access. Small businesses have been naturally drawn to these third parties and to sweeten the deal, the alternative model allows borrowers to apply for loans anywhere, anytime and on any device—something very attractive to small business owners’ hectic, on-the-go lifestyle.
However, alternative lenders aren’t perfect—in fact, far from it. Even though they can render immediate decisions and expedite access to money, their funding cost is extremely high: 6 percent compared to about 0.7 percent for banks. Additionally, these lenders tend to have questionable regard for credit quality. They often consider unreliable factors such as social media presence when they make important loan decisions and introduce risk into their portfolios as a result.
Some banks have addressed these entrants by partnering with them, but at what cost? At the end of the day, reputation is the most valuable asset a bank possesses and by casting lots with these lenders—with their high interest rates and low credit quality—banks wager their credibility. So when borrowers experience issues down the road, they won’t blame the alternative lender but rather the institution they trusted to manage their funds. This not only risks irreversible relationship damage but also makes banks vulnerable as they give away critical channels they’ll need to establish in the future.
Unchanged, the higher-risk methods of alternative lenders can’t endure for the long haul.
In recent months, we’ve seen executives (including LendingClub’s CEO-founder) step down due to alleged scandals, rising chargeback rates and falling stock prices. As they struggle to find the right balancing point, alternative lenders have taught banks an important lesson. Borrowers will care about speed and convenience above all else, even more than cost of funding—at least, at first. Then what becomes of the “relationship”?
Forward thinking institutions are heeding the warning and starting to reengineer processes from within. Instead of simply placing an attractive veneer on existing systems, banks are incorporating automation and new technology throughout the lending process. That makes for a more convenient borrowing experience and also increases efficiency and loan turnaround time.
But how can banks embark down this path, and win back small business customers as a result?
What banks can borrow from alternative lenders
Process reengineering starts with application and decisioning. The alternative lending model attracts attention because borrowers can easily apply online and find out in minutes whether their request has been approved. But banks can accomplish this same feat—and with more responsible decisioning factors.
Pioneering banks leverage an automated decision engine to run loan requests against their proven, established credit policy, which creates a faster, more efficient decision-making process—while also ensuring optimal credit quality. If a decision isn’t clear cut and needs a more human touch, those requests can be automatically routed through the appropriate contact, which frees employees to focus on more complex cases.
While automated decisioning is a strong start, process transformation can’t end there. Powerful back end processing efficiencies must support this digitally forward, front-end experience: Otherwise, the process transformation loses meaning. Underwriting is where smaller credits typically slow down, so automation should extend to this portion of the process as well, routing loan review and approval with little or no touch.
Putting it all together: High-tech meets higher standards
When it’s almost time to close, proactive banks take steps to ensure document preparation and the streamlining of signatures. While these steps typically require an arduous amount of paper shuffling paper and repetitive data entry, that doesn’t have to be the case. Banks can leverage technology to aggregate data into the appropriate forms and present an e-signature option that saves both borrowers and lenders time and hassle.
Banks have the credibility and experience that come with hundreds of years of processing loans, and that represents a tremendous resource for the small businesses counting on them. But they must adapt. If banks take a cue from disruptors—and incorporate automation into a more efficient lending process as they digitally connect with borrowers—they can better serve their small business customers.
Yet they will also maintain their unequalled standards for superior credit quality as they bolster their bottom lines. For this gold standard, there is no alternative.
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As the chief innovation officer of nCino, Nathan Snell leads the company’s development team and is responsible for the maintenance and evolution of its bank operating system suite.