In today’s highly competitive banking world, smaller financial institutions are sharply focused on shareholders’ expectations for growth in earnings and return on equity. How can smaller organizations support earnings and ROE growth in the face of intense regulatory scrutiny and competitive pressures on profitability? One of the best ways is by leveraging their strengths in relationship lending, and their access to technology in order to grow the small business loan portfolio profitably.
U.S. small business lending is a $700 billion business, serving more than 29 million small businesses. The three major lending groups that currently serve small businesses are large banks, community banks and a more recent entrant to the lending sector – online alternative lenders.
Community banks, those with assets of less than $1 billion, have historically been a step ahead when it comes to fostering relationship-based lending. They are relationship bankers, characterized by local ownership, control and decision-making. They can make lending decisions based on personally knowing the character of the borrower, the collateral and the needs of the community.
However, a number of factors have resulted in a limited availability of loan funds for small businesses, and a hesitancy on the part of community banks to expand small business lending. These factors include limited resources compared to larger banks, recent acceleration of merger activity in the community bank sector, and increased regulatory burden that is proportionately higher for smaller banks than for large ones.
The average ratio of compliance expenses to non-interest expenses can be as high as 8.9% for banks with assets of less than $100 million compared with 2.9% for banks with assets of $1 billion to $10 billion. This constrains growth and diverts focus from unique business opportunities.
Significant Marketplace Changes
In 2010, commercial U.S. banks reported 19 million small business loans with an aggregate loan balance of $625 billion, according to data from the FDIC. At that time, large banks funded more than three-quarters of the total number of small business loans and 61% of the aggregate loan balance. Community banks, meanwhile, reported 22% of the total number of small business loans, with an aggregate loan balance of $242 billion, or 39%v of all small business lending by commercial banks.
Fast forward to 2016. Commercial banks altogether reported 23 million total small business loans, an increase of 4 million from 2010, with an aggregate loan balance unchanged of just over $627 billion. However, large banks by this time funded 87% of total small business loans and 68% of the aggregate loan balance.
These figures represent important changes from 2010. Small business loans funded by community banks dropped – both in number and aggregate loan balances. Indeed, community banks reported just 3.1 million, or 13%, of small business loans with an aggregate loan balance of $199 billion, or 32% of the total.
Alternative Lenders Address Unmet Needs
In recent years, online alternative lenders have also made inroads into small business lending. This group is highly innovative in their use of technology, and many borrowers are willing to pay the often higher rate these lenders offer in exchange for an easy application process, a quick decision and rapid availability of funds.
Online lenders have captured a rapidly growing share of lending since the financial crisis. In aggregate, the outstanding portfolio balances of these lenders have doubled every year since the mid-2000s. It is estimated that in 2015, online alternative lenders originated $5 billion in small business loans. While this amount represents only a fraction of U.S. small business lending overall, the rate of growth is notable.
Technology Opens Opportunity for Community Banks
Community banks looking for earnings growth should turn back the clock to the loan segment that defined community banking for decades – small business lending. Coupling the relationship focus these organizations are known for, with a technology-enhanced loan origination and onboarding process, smaller banks can begin to recover market share in small business lending.
By tapping technology advancements to change the workflow process, and rely less on staff and paper-intensive processes, community banks will be able to place the loan officer back in the role of developing new loan opportunities and building community relationships. At the same time, credit analyst can be placed back in the role of underwriting loans.
New technology innovations are available that eliminate data entry by scanning in tax returns, automate the spreading of financial data in minutes, price loans faster and more consistently, and score a loan using customized credit factors. What used to take days and weeks to approve and onboard a small business loan can now take organizations hours (or minutes), making quicker decisions available to borrowers who are eager to move forward.
Not only can deploying technology make the process more efficient for bankers and therefore quicker for borrowers – automation of certain steps in the process can also provide a more simplified, enjoyable experience for borrowers. For instance, solutions are available that allow upload of required loan information through an online loan application portal, majorly reducing effort on the part of borrowers to submit these documents.
Solutions that automate the final steps in the process can also send an automatic link to a third-party document preparation software for documents to be produced, reviewed and electronically pushed out to the client through the loan portal for closing. Professionals at the bank are able to provide an enhanced approval and onboarding loan process, resulting in happier small business borrowers who turn into loyal customers and advocates.
Time to Reclaim The Small Business Segment
Community banks have a unique opportunity to gain market share in small business lending by incorporating technology that can improve and speed their processes, meaning time and resources to bring on more borrowers, and giving them an edge in customer experience that will prompt the extra volume. In this way, community banks can leverage the benefits of local ownership and local decision-making, supporting the local community while also managing risk and growing profitably for shareholders.