Most retail bankers no doubt took note of the bulletin from the Office of the Comptroller of the Currency encouraging financial institutions to offer small-dollar, short-term loans to consumers. The document was intended to spur development of alternatives to payday loans.
A similar need and opportunity also exists in a market not covered by the OCC’s bulletin: loans to small businesses, particularly those early in their development cycle. Here, too, needs are often filled by high-cost options.
There are more than 30 million small businesses in the United States, yet this group remains a challenge and an untapped opportunity for many banks and credit unions. Financial institutions often struggle to find a way to serve these customers and fulfill their loans in a way that’s both profitable and efficient.
Savvy institutions increasingly are becoming aware that offering small-dollar loans to small businesses can offer near- and long-term gains such as protecting community businesses at a disadvantage and developing long-term loyalty. And, such loans can now be offered with greater efficiency, boosting profitability for financial institutions.
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No More Need to Take a Pass on Small-Dollar Loans
All financial institutions tend to deny more requests than necessary, chalking the decision up to being fiscally responsible or operating within their credit standards. While it’s obviously not advisable to compromise culture or credit policy, regional and community financial institutions should challenge traditional thinking — they should take a long, hard look at their internal processes and assess if they’re really doing everything they can to underwrite and structure loans for worthy small businesses. Most institutions will find that they’ve taken a pass because the immediate reward isn’t deemed worth the risk or cost. In reality, they could be losing the long game and a chance to support a backbone of their communities.
Turning down these opportunities is giving relationships away. If banks and credit unions can’t find a way to serve the small business borrowers that need them, they open the door for other organizations to take advantage of these opportunities, including online lenders like OnDeck, Kabbage and Lending Club. In fact, the top two reasons why small businesses turn to alternative lenders is because they believe they’ll be turned down at their financial institution and they think it will take too long to receive an answer from their bank or credit union.
The number of online, nonbank lenders — sometimes referred to as marketplace lenders — continues to rise creating unwanted, and unnecessary, competition for traditional financial institutions. The Great Recession opened a gaping hole that alternative lenders have gladly filled. Anyone with an algorithm and a decent web programmer has been able to offer “quick and easy” loans to small businesses. These loans often have notoriously high interest rates, setting small business borrowers up for greater financial challenges down the line.
Try Some Creative Partnering
Financial institutions are in a position to fix this problem by proactively finding ways to regain small business relationships. If a financial institution’s credit or risk profile won’t allow for a loan, there are other creative ways institutions can explore to maintain those relationships and serve small business borrowers. Some of the largest banks, for example, have partnered with alternative lenders (Chase with OnDeck) or have introduced their own payday lending options (U.S. Bank).
Other, smaller financial institutions, are also starting to partner with responsible third-party lenders to fulfill small business loans, but only for the short-term portion of the growth-cycle. Once the small business matures to a certain point, the bank or credit union is able to take back the loan. This allows institutions to protect small businesses from high-cost lending and maintain their relationships, even when credit policies or risk profiles prevent them from being able to fulfill the initial loan.
Small businesses mature to large businesses
The Federal Reserve’s Small Business Credit Survey has revealed that business owners are primarily motived by the borrowing experience and relationship when it comes to picking a lender — not by rates. This at least partially explains why so many small business owners turn to alternative lenders, despite the high costs.
Every business must start somewhere. While the notion of small businesses bootstrapping or attracting angel investors is a nice idea, the reality is that most every business, regardless of size, borrows money at least once every three years. A growing business may borrow more often than that. Providing an entry point with small, responsible loan amounts and repayment schedules is key for establishing a lifelong relationship with a borrower.
It’s not just loan amounts that will grow as small businesses mature; the total relationship margin will grow with them. According to McKinsey, U.S. small and mid-size businesses (SMBs) generate $90-$100 billion in revenue across lending and deposits, with each high-value SMB generating $4,000 in accounting profit to a bank per year. Small businesses will also expand their financial relationships with institutions that met their needs when they first needed help; BAI research found that about half of SMB owners keep their personal accounts with the same bank as their business accounts. The cost of expanding a relationship decreases and customer value increases with every product or service the business purchases.
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Efficient Platform Minimizes Staff Involvement
Many institutions make the excuse that they can’t make small-dollar loans to businesses because of the steep cost of fulfilling such loans. This is usually because of the extensive resources required to process them. Instead of declining to serve these small businesses, banks and credit unions should identify ways to make their lending processes more efficient.
A modernized loan origination process is one way to increase volume without raising costs or risk. Financial institutions should consider a single, centralized lending platform that automates manual processes, improves workflows, eliminates the shuffling of paper and streamlines renewals. Decision automation technology can be set to the institutions’ unique credit policies resulting in quicker decisions that follow responsible banking principles and reduce the amount of manual review while offering small business owners multiple loan options. Traditional lenders might be surprised at just how much can be accomplished before their lending team has to take action. Making these loans more efficient and pricing them accurately will allow banks and credit unions to profitably take on more business.
For example, a $2 billion-asset credit union located on the West Coast implemented a comprehensive digital loan platform to strengthen its business lending program. As part of this initiative, the credit union added staff, diversified its portfolio and started leveraging a centralized lending platform with automated workflows to provide a seamless member interaction. As a result, the credit union has raised its outstanding loans from $75 million to $600 million in just five years.
A negative perception of small-dollar loans shouldn’t dissuade banks and credit unions from pursuing relationships that could positively impact their institutions. By finding a way to serve creditworthy small businesses, institutions can better serve their communities, expand their portfolios and boost profitability.