Is small-business lending slipping away from large banks?

COVID-19 changed the stakes in small-business lending: While the top four banks provided 36% of small-business loans before the pandemic,  they disbursed a scant 3% in the first round of the CARES Act Paycheck Protection Program (PPP).

As large banks fumbled their PPP response, fintechs and smaller lenders stepped in to fill the gap. Online marketplace Lendio was among the standouts, facilitating $8 billion in PPP loans through its network of approved lenders. So was N.J.-based Cross River Bank, which underwrote 106,000 PPP loans worth $4.6 billion. For its efforts, Cross River expects to collect $163 million in fees, or 170% of its 2019 revenues.

While that’s a drop in the bucket for large banks, it’s also a warning sign of a more ominous trend: Without a course correction, they risk losing the lending market for small and mid-sized businesses (SMB).

When Small Isn’t Beautiful

Banks’ struggle to serve SMBs isn’t new. Small-business lending has always been a difficult fit within large banks’ portfolios. The loan amounts are modest, and borrowers’ profile risks are high due to a slew of factors that include limited operating history and heightened exposure to economic downturns, as well as a lack of collateral, financial resources and succession planning. In addition, small businesses typically can’t afford the fee-based services such as treasury management that are the bread and butter of large banks.

The SMB market was already tilting away from large banks before COVID-19. In 2016, small banks approved at least some of the amount requested for 76% of SMB applicants, while large banks approved 58% of applicants, according to a survey from the Federal Reserve Bank of Richmond.

Further, small banks earned a satisfaction score of 75 among approved SMBs compared with a score of 51 for large banks.

Capitalizing on Opportunity

Digital technology gave the final push – and the edge to small banks and fintechs. By lowering service costs and the barrier to entry, digital technology made it profitable to serve smaller accounts – a change fintechs in particular have leaped on.

It’s not hard to see the fit. Fintechs and alternative lenders boast advanced digital platforms that make the lending process simple and fast. Decisioning and funding is quick, typically less than a week. Point-of-need lending solutions are easy to use.

Yet large banks can’t afford to ignore SMBs. Small business is an anchor of the GDP – and banking. Representing one-fifth of global banking revenues, SMBs generate $850 billion of annual revenue for banks, a pool expected to grow 7% annually over the next seven years. The gig economy is further changing the look of small business: 32% of small businesses have only one employee, and that number is expected to grow as more people adopt the freelance model of work. PPP has shone a spotlight on the need to support this critical sector.

How to Course-Correct

For large banks, the opportunity with SMBs lies in valuating them in a different manner. Rather than the traditional model of commercial underwriting, lending to SMBs is in many ways more akin to consumer loans.

Here are some tactics large banks can take to boost revenue by capitalizing on the SMB market.

• Think about segmentation and specialization. Instead of being everything to every small business, choose a sector to specialize in. For example, Live Oak Bank focuses on segments such as veterinarians and dentists, both of which have huge capital needs for equipment. The practices won’t necessarily grow and scale, but they typically will require mortgages and other banking services and may eventually become wealth clients.
• Develop consistent alignment. Please. We see many banks try to connect the dots but run into trouble with execution. Many are still plagued by the industry’s longstanding practice of siloed functions and lack of integrated systems. They typically lack tracking capabilities that enable a fully integrated omnichannel experience – that’s a big drawback when it comes to servicing SMBs because fintechs’ and alternative lenders’ processes result in faster decisions and a superior customer experience. Small banks also thrive here because they know their customers personally and manage a much smaller number of them – an advantage that will likely serve them well as they navigate the PPP loan forgiveness phase.
• Partner with fintechs. Another trend we’ve seen is for banks to access this segment through partnerships or acquisition of fintechs. For example, online funding platform Biz2Credit is already integrated with SBA, and this partnership lets banks jump in quickly instead of spending months trying to figure out a path.
• Get creative. If your bank were to start a small-business offering today, and there were no restrictions about integrating it, what would you do? Starting from a blank canvas often helps stimulate the free flow of ideas for innovative products and services. For example, could you develop treasury management “lite,” with a limited range of services at a lower price point that meet SMB needs? One-size fits all is simply not appropriate for this segment.
• Implement advanced data and analytics. Amazon Lending made waves in June when it announced it was partnering with Goldman Sachs’ Marcus brand on small business loans. The move underscored both the value of lending partnerships and the role of data: Access to Amazon’s trove of details on its platform’s small-business sellers is considered a coup for Goldman. How can big banks similarly leverage their data, as well as their checking, savings and wire accounts for transfer? Is there a way to drive this segment at the point of need? Analytics can get banks to a more consumer-like level of personalization for SMBs that’s especially helpfully in today’s uncertain business environment. For example, they can enable lenders to find their way to business owners who present statistically better risks, such as, say, an SMB owner whose post-bankruptcy credit score hovers around 500 but once topped 800.

The unintended consequence of the coronavirus pandemic is that it reinforced the SMB marketplace’s move away from large banks that was already underway. There’s no going back to the old ways, and neither large banks nor SMBs want to.

To learn more, please visit the Paycheck Protection Program Forgiveness Solution section of our website. 

Visit our COVID-19 resources page for additional insights and updates.