Mary Ellen Biery
Mary Ellen Biery Nov 7, 2018

The top three problems with small business lending—and how to fix them

Is growing the small business loan portfolio on your bank or credit union’s agenda? If so, you’re not alone. A recent survey by the American Bankers Association found that 61 percent of banks surveyed plan to moderately or aggressively grow their small business lending (loans between $3 million and $100 million) over the next two years. In other words, many financial institutions will vie for the same small and medium-sized lending business.

Yet will doing that be easy? Not necessarily. BAI industry insights presented earlier this year at a business banking executive workshop show that business banking loan growth declined in 2017 more than anytime in the past five years at 5.2 percent. Of the largest loan categories, the only one to show any growth between 2013 and 2017 was SBA loans. And those rose just a hair in 2017, up 0.1 percent, BAI figures show. 

Some industry experts see positive signs. “Fifty-five percent of the owners of small and medium enterprises are willing to consolidate their personal and business relationships at the same financial institution,” says David Kerstein, president of Peak Performance Consulting Groupin a recent BAI Banking Strategies article on revenue growth.  

Naming the three small business loan roadblocks

With increased competition ahead, banks have two choices to win new small business loans: offer better pricing or easier terms than competitors. However, both approaches could hurt bank returns and potentially increase risk for the institution. They could also make small business lending more efficient and borrower-friendly so that the financial institution can win, process and manage more loans without big staffing increases or added expenses. Indeed, the surveyed banks most frequently identified the following as their top challenges in small business lending:

  • efficiency,
  • process, operations and staffing, and
  • cost.

About three-quarters of the nearly 200 respondents in ABA polling cited efficiency as a challenge when it comes to small business lending. The process/operations/staffing category was named by 62 percent of those surveyed, while 55 percent identified cost as a small-business lending challenge.

For most banks, the paper- and labor-intensive process of small business lending results in multiple handoffs between bank employees, frequent back-and-forth communications with customers and lengthy approval times, despite the small-balance nature of many small business loans.

“By the very nature of it, because it’s so transactionally based, loan operations can always be improved on,” said Alison Trapp, who leads the credit risk practice for Sageworks Advisory Services, during a recent webinar on process improvement. “How we manage the flow of documents is a huge piece of loan ops; how we store them appropriately; how we get them to and from our lenders or appraisers or the third-party vendors that we use—all of that stuff really opens itself up to process improvement. I think everybody wants to bring in the loans more efficiently.”

Life of the loan: Let’s get digital

Digitizing the small business loan from beginning to end can reduce processing time, which allows banks and credit unions to provide quicker, more transparent decisions. Life-of-loan digitization also makes it easier for high-salaried lending and credit professionals to focus on those loan decision aspects that require more intense analysis—especially if they need not spend as much time on duplicative data entry and tracking down components of the application.

However, only a tiny fraction of small business loans (0.1 percent) are handled digitally end-to-end, according to a 2015 survey of two dozen banks by Bain & Co. and SAP Value Management. The same survey found that only 8 percent of small business loan applications are submitted on digital channels. Smaller banks, in particular, tend to lag in lending technology adoption, which means they have tremendous opportunity to make small business loans more efficient and profitable.

End-to-end, but to which end? Build or buy?

While some banks build their own end-to-end solutions, others are working with technology partners to expedite their ability to originate, underwrite and close small business loans. The ABA report outlines three advantages for banks that partner with fintechs that offer an end-to-end digital lending solution:

  • Compared to developing a solution in-house (assuming the bank has the expertise and resources to do this), the cost of implementing a Software-as-a-Service solution (SaaS) from a technology partner is lower.
  • The bank can unveil new online products and services under their own brand, which bolsters brand value with current customers and prospects.
  • The bank can customize the platform to fit its lending and risk management practices, and it can more easily adapt to future changes.

Some fintech firms can also assist financial institutions with process improvement and change management to work through whichever policy and operational changes are required for meaningful efficiency improvements.

It’s common knowledge that banks able to innovate and leverage new digital lending technologies will be well-positioned to compete. Originating and servicing these loans must be cost-effective but there will be challenges to get there and win the SMB loan game. Competition, always a factor in the past, could grow even more intense. In solving the small business lending puzzle, it pays more than ever to keep the three top problems top of mind.

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Mary Ellen Biery is a research specialist at Sageworks, a financial information company that offers financial institutions lending, credit risk and portfolio risk solutions.

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