Those of us with gray hair will remember Tom Peters’ seminal 1997 work, The Circle of Innovation. A snapshot on leadership and organizational change subtitled “You can’t shrink your way to greatness”, Peters’ book argued that the world of business was in a permanent state of flux, requiring constant change as the only survival strategy. This is certainly true generally for banking and particularly for business lending. As digital lending becomes prevalent, the temptation to “shrink”—or at least defer change—may significantly impact a bank’s ability to survive and grow.
Business lending is changing rapidly. National lenders have transformed the borrowing experience with technology. Marketing claims about a fast and convenient process, backed up with simple online applications and instant funding, have changed the game. As a result, banks that have digitized small credits are taking over the market: nationally, the top five lenders now write over 50% of sub-$100,000 business loans. Many bankers shrug at these numbers; small credits are unprofitable and often underwritten only as a courtesy to customers.
However, the news gets grim for banks still lending the old way. Having perfected the customer experience and gained considerable understanding of credit policy and risk management of small loans, these same national lenders are now moving upmarket into larger credits. The clearest example is American Express. Over a two-year period, AMEX’s originations under $100,000 grew 36%. At the same time, AMEX’s originations for business loans between $100,000 and $1 million grew a whopping 90%!1
Don’t believe this is happening in your market? Scan recurring ACH payments from your business customers to AMEX, other national banks, and alternative lenders—that will give you a sense of vulnerability. With every customer that borrows elsewhere, a bank’s relationship with the customer—and the opportunity to gather deposits, sell treasury products, and acquire personal banking relationships along the way—gets weaker.
Assuming a desire to compete and win in this environment, how does a bank assess available solutions, all of which in some way improve on current processes and deliver value? Digital business lending technologies can be summed into three categories:
Process automation for gaining underwriting efficiency. These are traditional loan origination systems that have been available for years and effectively reduce manual underwriting effort by automating workflow. While these systems reduce costs, and many have recently added online application forms, they do not deliver the kind customer experience (and associated marketing claims) that will capture the attention of business owners and drive growth.
Outsourced digital lending through alt-lenders’ platforms. These newcomers have cracked the code in business banking. They continue to grow rapidly by delivering a great experience that speeds borrowing and lets customers focus on running their businesses. In turn, business owners pay significant premiums—well into the double digits—for convenience and more importantly, the certainty of funds availability in a shorter-than-typical time frame.
But for banks, using these solutions has its downsides. Funding loans from a black-box credit policy leaves banks without conviction about the quality of the loans, and potentially raises examiner issues.
Some banks have gotten past this by lending only to the best applicants and farming out the bulk of the loans to the alt-lender. However, with this approach the bank is mainly a market-maker for the alt-lender and, in the end, is selling off its business banking relationships. Either way, a bank may be left in a dangerous place long term.
Real-time lending through digitization of a bank’s credit policy. This is essentially what AMEX and the national banks have done: segment the applications through a rules-based system to decision and price loans based on objective characteristics. The benefits of this approach are manifold. Underwriting segments instead of individuals provides consistent application of the credit policy which ensures quality decisioning, a clearer picture of portfolio performance, and the ability to “turn the dials” on the policy in a controlled and measurable way. It also enables prescreening businesses, which in turn allows a bank to market only to those businesses that have passed the rules and are highly likely to be approved. And because businesses are prescreened before they even apply, the online application is much simpler; just a handful of questions are required to validate what is already known about the business.
Your choice among these options should be informed by your business banking strategy. Next week, we’ll discuss the key considerations in making this decision.