Big Drivers of Small Business Loans

By Chet Kamat

Small businesses are unsung customers for banks. While small businesses tend to be overshadowed by large corporates, they are in fact key customers and contribute significantly to the overall loan business. In the U.S., debt account and credit card financing for small businesses accounts for more than $780 billion in revenue and $10-15 billion in profits.

While banks are the largest financiers to the small business community, many have yet to maximize the opportunities that small business financing offers. According to the IFC, there is a financing deficit of approximately $2.1 to $2.6 trillion worldwide, equivalent to 30-36 percent of current outstanding small business credit.

Some financial institutions are shying away from offering small business financing solutions—largely because of the difficulty of analyzing these customers’ credit risk. Furthermore, the complexity and costs involved in originating and servicing small business loans are quite high when compared with the size of the deals. Recent regulatory frameworks have increased the cost of processing small business loans, further deterring banks from funding small business customers.

The threat of alternative financing

Recognizing the untapped opportunity in lending to small businesses, several fintech companies, non-financial institutions and tech giants have begun to fill the gap. These new players have created specialized and innovative financing solutions for small businesses across the credit value chain. In some cases providing superior experience, faster origination and novel risk analysis and underwriting capabilities, they have been rapidly gaining market share. While banks still have a strong foothold in the small business lending space, the possibility of being displaced from their position as market leaders in the near future looms large. In fact, 30 percent of consumers who have not tried a nonbank product or platform before said they are open to trying them, according to Oracle’s New Digital Demand in Retail Banking report. The need to transform small business financing solutions should therefore be a key priority for banks if they wish to retain a significant portion of their revenue.

How can banks stay competitive?

If banks play their cards right, they can increase revenue and profits as a result. Banks need to gain the following set of capabilities to stay competitive and mitigate threats from new digital players:

• Address diverse credit needs. While these enterprises are small and less complex in terms of size and processes, they nevertheless have the same credit palate as large organizations. To improve their working capital, small businesses expect diverse credit solutions from their banks including term loans, inventory financing, working capital loans and invoice financing. They also expect banks to not only have the capability to tailor their credit solutions specifically for the small business industry, but also offer customized solutions for specific business situations.
• Analyze unconventional data. Typically, small businesses do not have a rich credit history and public information about these companies is not easily available, making it difficult for banks to calculate their credit worthiness. It is even tougher in the case of startups. Banks need to be in a position to capture a startup’s business plan and generate a cash forecast. They will need digitized risk analysis tools that go beyond conventional methods of analyzing a customers’ risk profile. Banks should be able to collect and analyze patterns from conventional and unconventional data, such as stakeholders’ social profile and job history, and use predictive analytics to forecast an accurate picture of the credit worthiness of a customer. This will enable banks to qualify and extend credit to a larger number of small business customers.
• Pre-qualify credit line during onboarding. Banks should incorporate technology capabilities to capture and compute financial information, pre-qualify and set a maximum limit for various credit opportunities when the customer is on-boarded. The ability to understand customer history, benchmark the business against industry standards and assess future risk factors can simplify loan origination to just a drawdown, enabling customer financing within a matter of days instead of a couple of weeks. For instance, a leading bank in Canada today uses a simple three-step process to finance customers within 24 hours. It also benefits the customers, as they are aware of credit opportunities upfront.
• Proactively manage credit. Having the ability to track in real-time the small business customer’s holistic profile including credit and non-credit information, such as suppliers, partners and the economic interdependence of all parties, will help a bank accurately gauge the aggregated risk exposure and decide on the type of repayment schedules needed. Using intelligent ways of recognizing relationships can also create opportunities to sell new credit offerings. As small businesses continuously evolve to enhance revenues and profits, banks can actively participate to enable their growth.
• Customer self-service. Small business customers prefer self-service digital experiences as it gives them greater control of their banking transactions. A leading bank in New Zealand has a self-service capability that enables the customer to apply for loans directly from its website, and the bank offers its decision within a matter of seconds. It makes complex processes simpler and not all banking transactions are personnel dependent. Transactions can be done quickly and efficiently. Furthermore, faster credit assessment models and proactive pre-qualification, self service capabilities help banks satisfy customers that need funding in a few days.
• Support open APIs. If executed correctly, the benefits of open APIs are multifold. Banks can leverage open APIs to build innovative applications in-house or open up their systems and partner with third parties to address the unique needs of small businesses. Another important aspect of open APIs empowers banks to easily build a connected financial ecosystem across internal and external stakeholders. With these connected relationships, banks can help small businesses connect with a larger ecosystem.

For many years, small businesses were highly dependent on banks for funding, but throughout the last few years, more are turning to fintech firms for financial solutions. In fact, 33 percent of small business borrowers are convinced that they will receive funds only from these alternative lending fintech companies, according to a World Economic Forum report.

While these fintech firms are capturing the bank’s market share, banks still have an opportunity to win a larger share of the pie. All they need are the right key capabilities. These capabilities include credit assessment models that are real-time and can tap into unconventional data sources, superior digital offerings and the ability to pre-qualify appropriate credit early in the onboarding process. These “enablers” will ensure banks always stay at the top of the game when it comes to small business financing.

Chet Kamat is SVP for banking at Oracle Financial Services.