How to Fix the 3 Biggest Problems with Small Business Lending

Mary Ellen Biery
April 24, 2018
Read Time: min

Is growing the small business loan portfolio on your bank or credit union’s agenda? If so, you’re not alone.

A recent survey by the American Bankers Association found that 61 percent of banks surveyed plan to moderately or aggressively grow their small business lending (loans between $3 million and $100 million) over the next two years. In other words, many financial institutions will be vying for the same small and medium-sized businesses when it comes to lending.

Top problems in small business lending

With increased competition ahead, banks have several choices for winning new small business loans. They could offer better pricing or easier terms than competitors. 

However, both of those approaches could hurt bank returns and potentially increase risk for the institution. Another option is to make small business lending more efficient and borrower-friendly so that the financial institution can win, process and manage more loans without big increases in staffing or other expenses. Indeed, banks surveyed by the ABA most frequently identified the following as their top challenges in small business lending:

  • Efficiency
  • Process, operations, and staffing and
  • Cost.

About three-quarters of the nearly 200 respondents cited efficiency as a challenge when it comes to small business lending. Process, operations, and staffing was named by 62 percent of those surveyed, while 55 percent identified cost as a small-business lending challenge.

“For now, non-bank alternative lenders have the upper hand on efficiency,” the ABA said in its report, The State of Digital Lending. “Operating expense as a percentage of outstanding loans run at approximately 6 percent at banks that use traditional processes, compared to less than 2 percent at the non-bank alternative lenders.”

For most banks, the paper- and labor-intensive process of small business lending results in multiple hand-offs between bank employees, frequent back-and-forth communications with customers and lengthy approval times, despite the small-balance nature of many small business loans.

“By the very nature of it, because it’s so transactionally based, loan operations can always be improved on,” Alison Trapp, who leads the credit risk practice for Abrigo Advisory Services, said during a recent webinar on process improvement. “How are we managing the flow of documents is a huge piece of loan ops; how are we storing those documents appropriately; how are we getting them to and from our lenders or appraisers or the third-party vendors that we use -- all of that stuff really opens itself up to process improvement. I think everybody wants to bring in the loans more efficiently.”

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Life-of-loan digitization in small business lending

Digitizing the small business loan from beginning to end can reduce processing time, allowing banks and credit unions to provide decisions more quickly and transparently. Life-of-loan digitization also makes it easier for high-salaried lending and credit professionals to focus on those aspects of a loan decision that require more intense analysis if they don’t have to spend as much time on duplicative data entry and tracking down components of the application.

However, only a tiny fraction (0.1 percent) of small business loans are handled digitally end-to-end, according to a 2015 survey of two dozen banks by Bain & Co. and SAP Value Management. The same survey found that only 8 percent of small business loan applications are submitted on digital channels. Smaller banks, in particular, have tended to lag in technology adoption for lending, the ABA said in its report, which means they have tremendous opportunity to improve efficiency and profitability of small business loans.

“It used to take days and weeks to approve and onboard a small business loan,” says Abrigo Vice President Neill LeCorgne, who works with financial institutions to enhance operating strategies. “With the right technology, even a community bank can complete the process in hours.” LeCorgne estimates that the typical steps in the SMB lending cycle can require nearly 31 hours and $2,250 of labor costs. By automating the time-consuming processes, financial institutions can expedite the process, cutting their labor nearly in half, he says.

Build vs. buy an end-to-end solution?

While some banks are building their own end-to-end solutions, others are working with technology partners to expedite their ability to originate, underwrite and close small business loans, the ABA report noted. It outlined three advantages for banks that partner with fintech firms offering an end-to-end digital lending solution:

  • Compared to developing a solution in-house (assuming the bank has the expertise and resources to do this), the cost of implementing a software-as-a-service solution from a technology partner is lower.
  • The bank can offer new online products and services under their own brand, which bolsters brand value with current customers and prospects.
  • The bank can customize the platform to fit its lending and risk management practices, and it can more easily adapt to future changes.

In addition, some fintech firms are able to assist financial institutions with process improvement and change management in order to work through policy and operational changes that may be required for meaningful efficiency improvements.

As the ABA noted, banks by their very nature have some notable advantages over online or alternative lenders when it comes to small business lending. “They have stable, low-cost funding and a long experience managing credit risks through business cycles,” the report said. “Equipped with these competitive advantages, banks that innovate and leverage new digital lending technologies will be well-positioned to compete—as long as they can make it cost-effective to originate and service their loans.”

About the Author

Mary Ellen Biery

Mary Ellen Biery is a Senior Writer and Content Specialist at Abrigo.

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About Abrigo

Abrigo is a leading technology provider of compliance, credit risk, and lending solutions that community financial institutions use to manage risk and drive growth. Our software automates key processes — from anti-money laundering to fraud detection to lending solutions — empowering our customers by addressing their Enterprise Risk Management needs.

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