Small Business Lending: A For-Profit Business
Vice President of Product Development, Cloud Lending Solutions
There is nothing small about small business. There are 28.8 million small businesses in the United States, and small businesses make up 99.7 percent of all businesses in the country. Small businesses are the engine that drives our economy, so ten years ago when our economy was in the depths of recession, it’s not surprising that small businesses were the hardest hit. 2008 to 2010 saw an overall reduction of 20% in commercial and industrial lending by banks, which led to a 40% reduction in jobs at small businesses during the recession, representing the majority of all private sector job losses. Economists attribute at least some of these job losses – as much as 8% – to lack of lending to small businesses.
Today, banks are lending to small businesses again, however a lack of access to capital is still among the greatest threats to the growth of small business. 1-in-4 small businesses say they cannot get the funding they need to grow their business, and a further 67 percent of small businesses have gaps in funding, which leads a large majority (75 percent) of small business owners to address funding gaps with personal financing. So why are small businesses finding it so difficult to get access to capital?
Profitably lending to small businesses has historically been a challenge for many community and regional banks. Many banks apply the same underwriting and due diligence standards required for larger commercial loans to small business loans, resulting in a highly manual and highly unprofitable small business loan origination process. As a result, many of these banks prefer to focus on larger, more lucrative commercial loans. And with fewer and fewer banks originating small business loans, a void has formed in the market, making it more and more difficult for small businesses to get access to capital.
Alternative lenders, like OnDeck and Kabbage, have stepped into to fill the void, approving small business loans at unprecedented rates. So how do they do it? First, alternative lenders make capital available to a wider variety of small business owners – for example, alternative lenders may not require a business plan, collateral or even a high credit score. The result is approval rates of 58 percent or higher. Second, alternative lenders leverage technology, automation and digital engagement to originate small business loans at scale, reduce the cost of origination and increase profitability. Kabbage and OnDeck, for example, enable small business owners to apply for a loan online, receive instant approval, and funding within 24-48 hours. As a result, alternative lenders now make up nearly 20% of the small business lending market. It sounds hard to believe, but it is true. Using leaner underwriting strategies, third-party data, digital engagement and automation to accelerate the origination process, alternative lenders have disrupted the market and set a new digital standard for small business lending.
Community banks and credit unions can learn from the success of these alternative lenders. You can use the strategies that alternative lenders have used to disrupt the market as a blueprint to fill a critical credit need, expand market share, and build a sustainable, profitable small business loan portfolio. But before we develop our blueprint, let’s examine the small business lending opportunity.
First, it is an exploding market. Economists project the online small business market to reach nearly $200 billion (that’s billion with a “B”) in the next 7 years.
Second, though alternative lenders approve small business loans at a higher rate than traditional banks, the easier/faster approval process comes with a price to the small business. While average annual interest rates among traditional banks (both large and small) currently hover between 2.5 and 5.5 percent, alternative lenders have the highest interest rates in the industry, averaging between 13 and 71 percent. Thus the trade-off for higher approval rates and faster qualification with alternative lenders is significantly higher interest rates. This is the chink in their armor.
The alternative lender blueprint for small business is fairly simple – leverage technology, automation and digital engagement to lend to small businesses at scale. However, community banks and credit unions bring an intrinsic competitive advantage – a lower cost of capital. By leveraging technology, automation and digital engagement to achieve faster qualification and approval, and by offering small business loans at significantly lower interest rates, community banks and credit unions have an opportunity to take back the market.
Blueprint for small business lending nirvana
Blueprint for small business lending nirvana
- Provide online/omni-channel small business loan applications and origination tools that provide a modern, intuitive and personalized borrower experience
- Improve process efficiency by automating redundant tasks, digitizing paper-based processes and streamlining the loan origination lifecycle
- Centrally enforce credit and organizational compliance policies to ensure organizational control and policy compliance, without sacrificing speed
- Eliminate manual entry and rekeying to promote speed and accuracy throughout the loan origination process
- Evaluate your credit risk program to ensure that it properly accounts for inevitable changes in the risk profile and makeup of your loan portfolio, such as risk ratings, loan loss/reserves and concentration
- And finally, wield your biggest weapon…the ability to lend money to small businesses at lower interest rates
First, you need to leverage a technology platform that enables you to digitally manage the origination process, centrally enforce policy rules and stipulations, automate redundant tasks and maintain visibility and transparency throughout the process. Reducing the time and effort associated with small business loan origination is a key component of a scalable and profitable small business lending strategy. This is achieved by leveraging a technology platform that eliminates paper, automates scoring and pricing, digitally routes and manages origination tasks and approvals, manages document requirements, enforces policy compliance and disburses funds.
Next, you need to provide a modern, intuitive and personalized omni-channel experience to your borrowers. Your front-end user interface should be easy to use, support desktop and mobile devices, and integrate seamlessly with the loan origination system. It is not uncommon for a small business owner to start an application online, and then come into the branch to finalize the process, and your small business solution and strategy should enable borrowers to seamlessly transition from channel-to-channel without any loss of fidelity.
Finally, you should leverage a trusted partner to guide you through the process. Success in the small business lending space requires the right technology, executive buy-in and organizational change, and an experienced implementation partner can help you put all of the pieces together to achieve a leaner, faster small business origination process, an engaging borrower experience and most importantly, a sustainable and profitable small business lending strategy.
Cloud Lending Solutions can help you achieve small business lending nirvana.
The Cloud Lending Solutions platform is a comprehensive set of products and solutions that enables you to increase loan production while reducing risk, increase efficiency while strengthening compliance controls, delight and empower your borrower, and originate small business loans faster and more profitably than ever before.