The small business lending market has undeniably changed since the onset of the coronavirus pandemic.
In previous times of crisis, small business lending activity has dramatically declined, as lenders were only willing to issue loans to the most creditworthy borrowers. However, in the early stages of the pandemic, the federal government introduced the Paycheck Protection Program (PPP). The Small Business Administration (SBA) backed PPP loans ultimately provided nearly $800 billion in funding across more than 11 million loans, many of which went to small business owners who wouldn’t have qualified for traditional loans, even in normal times. The loan program played a significant role in the fast economic recovery, providing politicians with a blueprint for fending off future crises.
The banking industry had no choice but to scrap legacy processes in favor of digital strategies that rapidly accelerate the “time to cash” for small business owners. The massive Paycheck Protection Program, coupled with a pandemic that made in-branch customer interactions a public health risk, forced lenders to fix the inefficiencies that have traditionally plagued the small business lending model. In addition, financial institutions learned that small business loans could be one of their most profitable segments if they put suitable systems in place.
As it stands, the total market for digital lending and credit in the United States is at least $743 billion. Of that $743 billion, $446 billion can be attributed to small banks and $297 billion to large banks. This does not account for the large volume of loans that were made in 2020 and 2021 via the PPP, but represents all other digital business lending.
The success of SBA lending programs in the last two years, and the digitization of lending processes that resulted could make private business lending a $1 trillion+ market shortly.
How Can You Expand Your Bank’s Market Share of Small Business Lending?
To expand your bank’s share of the small business lending market, you need to be able to provide financing options to a wide range of borrowers quickly. A digital lending platform can help you accomplish those objectives.
With a digital lending platform, you can accelerate the loan origination processes and monitor borrower behavior so that you can proactively reduce loan delinquencies.
Let’s start by looking at the loan origination processes:
In the past, small business owners had to undergo a lengthy application process to qualify for a small business loan at a bank. They would have to attend multiple in-person meetings – an inconvenience pre-pandemic, but an inconvenience and a health risk since the onset of the pandemic. The applicant would also be asked to fill out a lot of paperwork – some of which had little to no impact on the approval or denial decision. After receiving the application, the bank would manually review the prospective borrower’s financial statements to see if their annual revenue and other financial metrics qualified them for a loan or line of credit. It typically took at least a few weeks to render a decision.
These days, there aren’t many banks and credit unions that have all of the above inefficiencies, but there are a lot that have some of those inefficiencies. By revolutionizing the underwriting process, a digital lending platform can streamline the “time to decision” and “time to cash.”
Here’s how a digital lending platform can provide a much better user experience with a fraction of the human resources required in the traditional model:
A digital lending platform eliminates the need for in-person meetings and unnecessary paperwork, simply asking the borrower to provide the necessary information from the comfort of their own home. There is software that can check client inputs against proprietary credit and capital verification sources, allowing your bank to assess the borrower’s creditworthiness and quickly settle on the pricing of the loan.
There are also gains to be made with loan portfolio monitoring:
A large number of banks and credits unions are unaware of what’s happening across their loan portfolio. For example, if a banker enters financial covenant agreements into spreadsheets, the banker may not learn of a breach in time to take action. The other issue is that even if a banker gets alerts in time, it’s challenging to analyze key metrics across the portfolio with a piecemeal solution.
Let’s consider a hypothetical situation:
Your bank has a loan portfolio that includes commercial real estate loans and equipment loans to startups. The commercial real estate part of the portfolio is performing well, as the borrowers are having no issue leasing their properties. On the other hand, a number of startups are struggling, and their working capital has plummeted below what your financial institution has deemed to be a safe threshold. With a legacy solution, you might not realize what’s happening with all of these borrowers until it’s too late to get them back on track.
A digital lending platform can make loan portfolio monitoring a breeze for financial institutions. The loan servicing software can monitor borrower behavior in real-time, providing alerts when a borrower is showing potential default signals. In addition, the exemplary system gives you the ability to analyze your portfolio at a high level.
What Can Banks Learn from Alternative Lenders?
The Biz2Credit Small Business Lending Index is an analysis of 1,000 monthly loan applications on the Biz2Credit website. In October, alternative lenders approved 25.6% of their loan applications. Big banks had a loan approval rate of 14.1%, and small banks approved 19.7% of small business loan applications.
Financial technology (fintech) lenders typically have higher loan approval rates than banks because they have less stringent requirements for small business loans. According to Biz2Credit CEO Rohit Arora, “Non-bank lenders typically focus less on FICO scores and more on the financial health of the borrowers who are applying for funding.” In many cases, lower credit score borrowers have to pay a higher interest rate to secure a small business loan from an online lender. Since these borrowers don’t have a lot of financing options, though, they are often willing to make the higher payments.
Of course, it would be irresponsible for banks to abandon their lending standards and approve questionable loan applications. But there is a middle ground where banks can support a higher percentage of borrowers without seeing an increase in their default rates. This can be accomplished by building complete profiles of small business owners that focus on their financial health instead of being boxed in by the limitations of traditional metrics.
Adaptability is Necessary to Thrive in the Small Business Lending Market
Over the last two years, the small business lending market has evolved in ways that very few people would have predicted at the beginning of 2020. There was a nearly $800 billion SBA loan program, the Federal Reserve has committed to keeping interest rates very low for the foreseeable future, and digital lending processes have become an expectation among small business owners.
The banks that have thrived over the last two years have quickly adapted to each new development.
So, what’s in store for 2022 and beyond?
It’s impossible to say for sure, but likely, borrowers will increasingly expect financing options that seem to be tailor-made for them.
The consumer lending market may provide hints of what’s to come in the B2B market, as the digitization of consumer’s lives – aka “The Amazon Effect” – ultimately led consumers, many of which are small business owners, to expect their financial institutions to meet their business needs in a couple of days or less.
A popular B2C trend is buying now and paying later (BNPL), allowing consumers to get low or no short-term interest financing. The traditional options for small business owners for short-term financing – invoice factoring, invoice financing, business credit cards, and merchant cash advances – are often expensive ways for entrepreneurs to access short-term liquidity. So, this area of the banking industry could be disrupted in the coming years.
That’s just one possible example of what could happen shortly, but the point is, financial services companies need to be on the lookout for new ways to assist small business owners.
A digital lending platform can provide you with the ability to adapt to changing conditions and thrive in any small business lending environment.
You Need the Right Digital Lending Platform
To capture a sizeable amount of the growing small business lending market, you need to have systems in place to provide financially healthy borrowers with the right financing option for their business purposes. At the same time, you need to continually monitor your risk profile to ensure that you are not jeopardizing your financial institution.