The Miserable State of Small Business Banking
The state of small business banking at most banks, that is, their ability and willingness to serve the needs of small companies, is at its nadir. Despite all the hype from banks about how they support small businesses, the reality is substantially different and more businesses are recognizing this gap.
What’s happened to bring banking to this low point with what should be one of its major target segments?
The value of small business deposits is down. The majority of small businesses are not borrowers and balances have long driven the total profitability of a bank’s small business portfolio. With interest rates near zero, the lower loan/deposit ratios at many banks undercut the value and attractiveness of this reliable deposit source; many banks are unable to lend their deposits at attractive returns and, therefore, are avoiding deposit-rich targets.
Companies have reduced their borrowings. Many small businesses remain concerned about the slow growth economy and have reduced their growth plans and borrowing needs. The most recent Thomson Reuters/Pay Net Small Business Lending Index shows that “lending to small U.S. businesses plunged in September to the lowest level in 14 months,” whether as a result of lender or banker reticence. In many cases, banks are targeting highly conservative borrowers with similar lending offers, leading to an oversupply of funds for certain customers and a lack of borrowing options for others.
Banks have narrowed their credit box too tightly. A recent article in Inc. magazine details how banks have abandoned many small business customers, reporting that from 2008 to 2010, the volume of business loans dropped some 22%. In cash terms, commercial lending experienced a $325 billion decline over those three years; the volume of small business loans (generally defined as loans of less than $1 million) fell by $26 billion and then kept falling. By June 2012, small business loans were down $56 billion from their 2008 peak of $336.4 billion.
Banks have tightened their lending criteria in a number of ways: excluding more industries and types of companies, requiring tighter covenants and stricter enforcement of those that are broken and reducing borrower leverage. Companies that generated poor results during the downturn are also avoided. More fundamentally, searching to free up equity, banks have cut back on their overall small business segment focus as part of their bank-wide deleveraging. In contrast, most other bank areas continue to be allocated appropriate levels of capital since they are viewed as part of the bank’s “core” focus.
The Inc. article presents examples of banks turning down current customers’ lending requests, which sends these customers scurrying to find replacement banks. Those customers are often gone for good. I remember being a young Citibanker decades ago calling on a list of assigned marketing names. One target I called recounted being declined by Citibank twenty years before my call and quickly hung up, telling me he would never deal with my bank.
The death of innovation. The only innovation occurring at most banks involves the application of technology in a lemming-like fashion by one bank after another. This is good news for technology firms and Information Technology (IT) consultants. But, in most cases, it is unlikely to move the dial in revenues or customer service, as banks layer in a higher level of costs to serve the same or a declining number of customers.
The potential for innovation within the small business space remains substantial. For example, many banks talk about the need and opportunity to link the business owner and the business in the bank’s offer yet few do so effectively. Worse, many banks believe they have a process in place to provide this type of solution; most of those institutions are fooling themselves.
In recent weeks, two senior bankers at top ten banks told me they had no time to focus on new product development. Instead, they were concentrating on assuaging the concerns of the regulators concerning their current activities. When could they consider new product ideas aimed at enhancing the customer relationship and building revenues? Maybe in another six months or more, but no earlier than in the second quarter of 2013.
The organization remains broken. Banks that lump in the smallest businesses (say, up to $2 million in annual revenues) with their overall business banking effort (often up to $10 million in revenues) are ensuring that they fail in selling and servicing lower-end customers. These banks’ sales staffs will quite naturally focus on larger companies.
Banks that lump in the smallest companies with the branches and expect branch personnel to sell and serve this segment are similarly condemning themselves to failure. Most branch people remain intimidated and unknowledgeable about small businesses. Executives at one large bank I spoke with recently acknowledged that their organizational approach was ineffective. However, one senior manager commented that no internal will existed to change how the bank was organized vis-à-vis this segment despite the need to do so.
Regulators are making the situation worse. It was Fed Chairman Ben Bernanke who said that banks should lend more to small businesses but that they should do so safely. This is a difficult statement to decipher and results in banks viewing regulators as giving them mixed messages. Frequently, governmental agencies do not talk with each other or coordinate their actions. Even more surprising, clients recount stories of different groups within the same agency failing to communicate a consistent message.
Whether intended or not, regulatory actions result in banks becoming more risk-adverse in their business lending, even to borrowers who in other times would have been viewed as credit-worthy. Today, no upside exists for a bank to “stretch” its lending parameters when it has the government looking over its shoulder more closely than ever. In this era of hyper-compliance, the bank’s lending upside is significantly less than the potential downside of regulatory criticism.
Implications. The fact is that the reticence and ineffectiveness of most banks in the small business space creates an opportunity for many regional and community banks. To exploit this opportunity, in many cases, banks need to bring in new hires who are knowledgeable in areas in which they currently lack skills, for example, working capital lending and, perhaps even more critically, sales. Only a handful of banks have the resources and the management leadership to travel this path.
Trying to retrofit bankers who specialized in commercial real estate to become working capital lenders will not work. Further, expecting bankers who have spent recent years monitoring loans behind their desks to jump in their cars and make 20 calls a week seems a fantasy. As is often the case when pursuing change, current personnel need to be supplemented or replaced. Even more difficult, in some cases these changes need to involve senior management.
One other major implication centers on the opportunity the banks’ failure to serve the business constituency provides nonbanks. Whether for companies like Sam’s Club, factors, merchant advance firms, check cashers or other “alternative” players, tremendous growth opportunities are available to these niche concerns. Recently, several business borrowers have expressed to me a willingness to pay higher interest rates to obtain increased funding in a shorter time than a bank could provide.
At most banks, focusing on strategy has lost out to compliance concerns and technology management. Increasingly, the needs of the customer are becoming an afterthought. Bankers should not be surprised if customers believe that banks simply do not care and look elsewhere to meet their needs.