Times are good right now for many small businesses.
The real economy is thriving. Small-to-medium businesses (SMBs) are hiring. Capital expenditures are rising. In fact, small business optimism recently hit a record high. So why do so many business owners still say they struggle to get the financing they need from their banks to grow?
Although SMB loan approval rates have picked up recently, they remain far below where they stood several decades ago. In particular, business lending tightened during the financial crisis of 2007–2008—and never really recovered.
Community banks—which specialize in the personal service small business owners depend on—have traditionally lent to small businesses at higher levels than large banks. But several factors still make SMB lending fundamentally tough:
- Understanding creditworthiness poses challenges due to a lack of standardized credit information and the diversity of business models.
- Customer acquisition channels are fragmented.
- The regulatory environment is complex.
- At the end of the day, it costs about as much time and money to process a $50,000 loan application as a $5 million application.
In recent years, online business lending platforms have emerged to tackle this problem head-on. By performing traditional bank underwriting accelerated by technology, these platforms create a rapid, efficient match of borrowers who seek capital with investors eager to lend. Customers can enjoy a customized, superior experience that falls in line with community banks' customer-focused philosophies—such as a simple application processes and dedicated account managers to answer questions.
With time, these platforms have proven more friend than foe to the banking industry. Under several partnership models, banks and platforms have found ways to team up—with each focused on what they do best and ultimately helping their shared small business customers prosper.
In awarding SMB credit, lending platforms claim some big advantages over traditional banks. Built from the ground up with 21st Century innovation, they lack the inefficiency of legacy processes and systems. They also enjoy advantages of specialization and scale—internationally in some cases—that allow them to refine their credit models, hone risk processes and perfect the customer experience.
This complements the areas where community banks succeed: building long-term relationships and providing knowledge and support as they meet small businesses’ other banking needs. Community banks bring a wealth of experience and knowledge of their customers, the local community and the broader marketplace—advantages no online platform can match. When these two sides work together, business owners obtain faster, more affordable loans delivered with a personal touch, which allows them to return to running their businesses.
Banks can work with business lending platforms in several ways:
- As investors: Banks can join other institutional investors such as asset managers, endowments, pension funds and investment funds, in funding loans through lending platforms. Investors can set up relatively quickly, with lending done on a passive basis. This allows banks to diversify their fixed-income portfolios with access to attractive risk-adjusted returns. Funding Circle counts Kansas-based INTRUST Bank as an investor, and this partnership serves as a model as we grow our platform. Some lending platforms also provide other investment opportunities via participation in securizations or the purchase of investment trust shares.
- Referral partnerships: With this option, banks proactively refer small business customers to lending platforms that are better placed to help. Likewise, lending platforms can then refer customers to the bank for day-to-day banking needs or services, such as international banking expertise, cash management and growth support. Beyond serving existing customers, these partnerships can also help both parties reach a new customers by combining a well-known, respected bank brand with the technology and marketing expertise of a lending platform..
- Leveraging technology: Some online lenders also license their platforms to banks, which allows them to provide capital to SMBs under their own brand without building a decisioning engine from scratch.
A critical element of any successful partnership is a well-defined set of goals on either side. Often, banks seek to partner with lending platforms to retain and acquire customers, generate loan portfolio yield and spur innovation. But this becomes insurmountable without an integrated plan before engagement begins. Although this seems obvious. many implementation cases not only exceed budget, but also fail to meet management's expectations. With many solutions available, it’s crucial to clarify beforehand the metrics used to measure results. Banks we interact with show equal interest in the yield on their loan portfolio as the yield on the latest digital and direct marketing deployment.
A successful partnership between community banks and lending platforms can make a significant, positive impact—not only for the partners involved, but the surrounding community as well. When small businesses can’t get financing to grow, it not only hurts the business itself. SMBs create the majority of American jobs and stunted access to credit creates a ripple effect in cities and towns nationwide. By working together, banks and lending platforms fuel this vital economic engine.
Again: Times are good right now for many small businesses. It’s high time, then, for lending platforms to join forces and work their strengths: to help ensure opportune times continue for all.
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Sam Hodges is the Co-Founder and U.S. Managing Director at Funding Circle, based in the San Francisco area.
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