By Dan Brown
ABA DataBank
Despite regulatory changes and technology developments, small business lending is still a relationship-focused business requiring customization, localized expertise, and a nuanced understanding of risk characteristics. Results from the Federal Deposit Insurance Corporation 2024 Small Business Lending Survey reaffirm the importance of relationship based-customized lending and identify competition and regulatory challenges banks face in this space. Below are some key highlights.
1. Small business lending remains a core banking activity and continues to require high-touch and relationship-based business practices to cater to specialized needs.
Small business lending continues to be a primary business line for banks of all sizes. According to the FDIC survey, 94 percent of small banks (defined as less than $10 billion in assets) and 90 percent of large banks made small business loans in 2021. These banks tend to focus on small business clients within their core markets. Figure 5.3 from the report highlights the reasons banks prefer to lend to small businesses within their core markets (note the figures in this staff analysis do not follow the order in the FDIC report). Specifically, local small business clients are easier to monitor for risk and intrinsic strength. Additionally, proximity helps to further assess local economic conditions and develop a deposit relationship.
In addition to the listed reasons for the preference towards local small businesses, critical components of the loan origination process still require in person interactions. Figure 6.1 of the report stresses how only 13 percent of institutions allow for loan documents to be signed online via website of bank app and only 19 percent offer online consultations regarding appropriate loan products.
2. Banks of all sizes are adopting new capabilities to improve lending processes but adapting new technologies while remaining compliant with regulations remains a delicate balance.
Despite many banks requiring in-person interactions for various components of a loan origination, banks in the United States have been incorporating new technologies at a rapid rate.
Figure 4.1 of the report demonstrates that more than half of surveyed banks either currently use fintech for their small business lending or are in the discussion or development process. In terms of current barriers for increased fintech utilization, risk and regulatory compliance are clearly some of the largest barriers. Figure 4.8 of the report illustrates some of the barriers preventing increased fintech utilization by surveyed banks. At the top, cybersecurity risk poses the largest barrier, with 91 percent of respondents saying cybersecurity poses a large or moderate concern for small business data security. Similarly, 79 percent of respondents said compliance or regulatory risk was a barrier preventing increased fintech utilization in the small business lending space.
3. Competition with credit unions and fintech lenders is increasing.
Competition from credit unions and fintech firms in the small business market has increased over the past few years. Figure 5.8 of the report illustrates the change in small business lending competition relative to the 2018 FDIC small business lending survey. While competition from other banks both large and small remains relatively the same (bands are touching the diagonal line), competition from both credit unions and fintech competition for surveyed banks increased relative to the 2016 survey (bands above the diagonal line).
Tax and regulatory advantages may be primary reasons for this increased competition. As previous ABA analysis has illustrated, significant tax differences between banks and credit unions contribute to relative advertising differences. Similarly, Figure 6.8 of the report provides evidence that tax differences may also help contribute to pricing advantages when credit unions price small business lending products. For fintech companies, their lack of comprehensive regulatory oversight allows for faster execution of small business loans relative to banks. Both of these policy differences are key drivers to the differences illustrated in Figure 6.8, which further reaffirms the need for a more level playing field between credit unions, fintech firms and banks.
4. Compliance complexity and high operational costs are significant barriers for small bank participation in Small Business Administration lending.
While SBA guarantees (for more information on SBA lending, see this primer) are a popular risk mitigation option for small business lending, survey respondents noted barriers inhibit smaller banks from
participating more in these programs. While proportionally smaller banks devote a larger share of assets to small business lending, 57 percent of small banks said they do not participate in government guaranteed lending compared to just 13 percent of large banks (Figure 2.10 of the report).
As to why small banks do not participate more in guaranteed lending programs, Figure 2.12 of the report illustrates that 48 percent of small banks report difficulty obtaining expertise and personnel for SBA lending. Additionally, compliance origination guidelines are an additional barrier to SBA lending for smaller banks. Considering smaller banks proportionally lend more to small businesses, and banks receive the highest satisfaction from surveyed small businesses on lending outcomes, further work should be conducted to understand how the SBA could increase small bank participation in guaranteed lending programs.
Conclusion
Despite new entrants and technological change, small business lending remains a predominately relationship-based line of business. Banks are incorporating new technologies to reduce processing times and improve user experience, but incorporating new capabilities amid increasing red tape is a difficult balance. Tax and regulatory differences between banks and non-bank competitors create an uneven playing field and make it harder for banks to compete. Finally, while SBA guarantees are a popular way to hedge risk when lending to small businesses, smaller banks face barriers to access these programs. These barriers constrain capital to the small businesses these programs are ultimately intended to assist.
For additional research and analysis from the ABA’s Office of the Chief Economist, please see the OCE website.
Dan Brown is senior director, economist, banking and financial services at ABA.
