With recent tariffs driving prices higher, especially for SMEs in the manufacturing, automotive, retail, logistics, healthcare, and agriculture industries, many banks are wondering if investing in an LOS system can help offset the losses of rising defaults.
Tariff-driven price hikes have led to a spike in late payments and loan defaults across the financial services industry. Even banks and credit unions that were once a steady pillar of small business lending have been caught off guard and now find themselves in a tightening vise as tariffs hammer their SME clients.
Digital lending solutions, such as loan origination software and SMB lending platforms, offer a solution for these banks. Digital technologies enhance risk management and profitability and are the future of SME lending.
The Effects of Tariffs on SMEs and Banks
Tariffs, higher input costs, and sourcing disruptions have increased economic volatility and eroded SME margins, particularly for supply chain-sensitive businesses.
One Goldman Sachs survey showed that 36% of small business owners are already feeling negative impacts from tariffs, and another 38% expect to feel them soon. Another 77% cite ongoing policy uncertainty as a major concern.
Elevated Risks of Non-Performing Loans
For small and regional banks, non-performing loan risks have increased due to declining margins and tariff pressures, especially in industries with already low profit margins. As expenses rise and revenue slows due to increased costs, many small businesses are missing loan payments.
Moody’s found that the average risk of default by U.S. firms reached 9.5% in late 2024 and is anticipated to stay high through 2025.
In the meantime, there were 371 bankruptcy filings during the first half of 2025, the highest number since 2010.
Banks have reacted by tightening their commercial lending standards, strengthening their risk management strategies, and increasing reserves to adjust for loan losses. But some are also undergoing digital transformations and looking to LOS systems to reinvent their loan origination process to offer more customizable loan products that better serve today’s business needs.
Compression of Net Interest Margins
Net interest margin (NIM), the difference between interest income earned from loans and the interest paid out on deposits and loans, is a vital profitability metric for regional and community banks. Smaller banks are more reliant on interest income from SME lending than larger national financial institutions that typically have more diversified revenue streams.
Although margins were significantly compressed in early 2024, they modestly rebounded by the first quarter of 2025, settling around 3.5% for smaller community banks and 3.4% for regional banks. Deloitte projections suggest, however, that NIMs will fall below 3% by the end of the year and continue dwindling into 2026.
For now, banks have responded by raising interest rates and fees, and some have also increased credit and collateral requirements or have delayed approvals.
Recently, however, the Feds have signaled that interest rate cuts are coming, potentially as early as September. Lower interest rates could result in a more promising SME lending atmosphere. Many SMEs might also consider refinancing their current debt to offset higher costs and shrinking margins.
Strategic Considerations for Small and Regional Banks in SME Lending
Banks can reduce the risks of loan defaults by amending their SME lending practices. The small business lending industry has more challenges to contend with than ever. Outdated practices increase the likelihood that your bank will experience an increase in non-performing loans.
A multi-tiered strategy can help your bank acclimate to current pressures while preparing for the unknown in tomorrow’s lending environment.
Advanced Credit Monitoring
It is more crucial than ever to monitor loan performance closely. Banks should act before a loan default occurs. Tracking real-time changes in cash flow, business activity, and payment patterns can help your loan officers spot troubling trends in borrower behavior.
Signs like unusual spending or late payments are a red flag that should prompt your loan department to intervene and potentially avoid a default.
Stronger Risk Management
Risk comes with the lending territory. But it must be proactively managed in a challenging environment like the present. Consider strengthening your bank’s loan review processes, adjusting guidelines as needed, and re-evaluating industries that are most affected by tariffs.
AI-powered loan origination software has advanced capabilities for evaluating borrower creditworthiness. Your financial institution will be better positioned to protect its loan portfolios from future losses by leveraging a loan origination platform to evaluate real-time insights of borrowers and lower the risks associated with underwriting.
Better Governance
Your bank’s internal policies and compliance oversight should continually adapt to current market conditions, especially when dealing with borrowers in high-risk industries. Loan departments and risk managers should have up-to-date resources and well-defined protocols to enhance accuracy and efficiency when evaluating borrowers.
Frequent internal reviews and open communication between departments will also ensure that everyone is aligned and making more intelligent decisions.
Stress Testing for Real-World Scenarios
Stress testing can help you understand how your bank’s loan portfolios will perform under pressure. Your bank should present real-world scenarios to determine which loans are more likely to default and how those defaults would affect your loan portfolio.
Stress testing can identify where your financial institution has the most risks and classify those risks by industry, loan type, or geographic area. This can guide your leaders towards the proper steps, such as building up reserves or revisiting loan terms with high-risk borrowers to help your bank be more resilient in a faltering economy.
Data and Technology for Better Decision-Making
Small and regional banks can’t afford to rely on gut feelings or outdated methods in an already challenging lending environment. Instead, your bank needs reliable, up-to-date information to make smarter, more confident loan decisions. That’s where AI-driven data can help.
Data from alternative sources, including payment history, supply chain stability, and real-time market conditions, provide a more accurate picture of borrower risk, industry trends, and economic shifts. It can also be used to flag higher-risk loans, identify customers who might benefit from refinancing, and plan for future changes in credit demand, default rates, or loan performance.
How Digital Lending and LOS Systems Can Help
Even during difficult economic times, banks and lenders can grow their loan portfolios and maintain their solvency with the aid of LOS systems.
These systems offer innovative solutions to manage portfolio risk, particularly as borrowers struggle to repay loans and banks without digital tools face financial loses due to increased expenses and bad loans.
Implementing an LOS system in your bank’s workflow can assist in the following ways:
1. Improved Risk Assessment
- LOS systems use real-time information to assess a borrower's credit risk level more quickly
- Evaluates figures like income levels, spending patterns, and credit scores to uncover customers who are higher risk
- Adjusts loan offers as economic conditions change
2. Faster Underwriting and Loan Approvals
- LOS systems automate reviews of borrower applications
- Renders quicker decision-making, whether to approve or reject borrowers
- Reduces paperwork and human error, which often results in lost time and fees for lenders
3. Real-Time Monitoring
- LOS systems monitor borrower financial, business, and transaction activity in real-time
- Detects missed payments sooner
- Sends automatic notifications for business loan accounts and follows up with reminders to stave off defaults
- Lowers the barriers to repayment with digital payment options
4. Stronger Loan Portfolio
- LOS systems test different loan terms and rates to determine what works best during challenging economies
- Lender guidelines can identify borrowers with less risky profiles to prioritize offers
- Improves revenue with fewer bad loans, even in uncertain economic times
5. Streamlined Regulatory Compliance
- LOS systems apply evolving policies and procedures automatically to maintain compliance
- Maintains thorough records for audits without requiring additional manual labor
- Lowers the risk of fines or penalties that can increase your bank’s financial burden
6. Tailored Loan Offers
- LOS systems use borrower data to create personalized loan options based on need and risk
- Provides flexible payment terms, which also lowers the likelihood of default
- Better meets the needs of clients and enhances the customer experience by cultivating stronger customer relationships and long-term loyalty
7. Centralized Data and Insights
- LOS systems keep all loan data in one place, making tracking and reporting easier
- Spot early trends, like rising defaults in specific areas or industries
- Uses dashboards and reports to make quicker, smarter decisions
SME Lending Outlook: 2025 and Beyond
SMEs will drive economic growth beyond 2025, prompting lenders to offer more flexible, tailored financing solutions for small business owners.
SME lending processes will become easier and faster to facilitate through digital banking and LOS systems. Many banks are also developing newer risk models that'll allow for working with different types of small businesses, even those that have limited credit history.
The demand for SME financing is expected to grow as more entrepreneurs enter the market and existing businesses expand. For your bank to stay competitive against lenders that prioritize the borrower experience, it must find the right balance between speed, service, and smart lending strategies.
Partnering with a fintech platform can help you leverage data for quicker, more informed decisions while keeping costs in check for both your bank and its customers.
FAQs
1. What can an LOS system do for banks?
LOS systems can manage and automate the entire end-to-end loan application process. They use software that integrates with third parties like credit bureaus, compliance systems, and data validation companies to enhance accuracy and efficiency in loan management. The result is streamlined, faster underwriting and decision-making, as well as better risk management.
2. What do SMB lending platforms offer?
The best platforms are cloud-based and integrate easily with your bank’s workflows, providing easy scalability. Key features should include CRM functionality and document management. It should be user-friendly and automate the entire lending lifecycle, including onboarding, application intake, funds disbursement, risk management, and loan servicing.
3. Why have loan defaults increased in SME lending in 2025?
Defaults are rising primarily because of the economic impact of new tariffs, which have increased costs for SMEs and shrunk profit margins. Many small businesses are struggling to keep up with loan payments, resulting in increased delinquencies and bankruptcies.
4. What can LOS systems and digital lending platforms do to help during uncertain economic times?
Digital lending platforms and loan origination systems (LOS) can benefit your lending operations by automating underwriting, monitoring loans in real time, and making faster, more accurate credit decisions. These tools enhance operational efficiency and risk management, lower operational costs, and reduce loan defaults by offering more flexible and personalized loan options.
5. What should my bank look for in a digital lending provider when considering an LOS system?
First and foremost, your bank should choose only reputable Fintech partners. They should have solid expertise in the banking industry with proven success in providing top-tier LOS systems. Digital lending partners should have integration capabilities, strong security protocols, and robust compliance tools. Finally, customer support should be a priority as your bank adapts its practices.
Ready for your bank’s digital transformation?Contact Biz2X today for greater success tomorrow.
