Small Business Lending Outlook

The following is the next installment in RMA’s Credit Risk Council 2016 Industry Insights: Perspectives from the Front Line.

Lending to small businesses has been a staple for our industry from the earliest days of our banking system. Ensuring capital availability for entrepreneurs is foundational for financial institutions regardless of size or location and, to this point, is consistently referred to by business owners as one of the key components of any successful banking relationship. A recent Small Business Credit Survey by several Federal Reserve Banks illustrates this point stating that “traditional bank lending continues to be the primary source of financing for small businesses.” However, the overall amount of lending to small businesses within the banking industry has fallen, as defined by most publicly available data (loan amount or company size being the most-widely used). Furthermore, there have been several high profile studies and articles forcing banks to reexamine their cost structure relative to small business loan origination.

Over the past decade, the landscape for lending to small businesses has become even more competitive with the entrance of alternative, nonbank lenders that leverage technology, marketing, and data in an effort to gain market share from the banking industry. These firms use unconventional underwriting practices and unique product features to streamline the credit process for small business owners and provide funding in as little as one day. Today, these alternative financing providers may be broadly categorized into three groups:

  1. Lenders that leverage their own balance sheet to extend loans.
  2. Lenders that rely on a peer-to-peer model backed by institutional and individual investors.
  3. Companies that provide a marketplace of options where small business owners can comparison shop among a variety of lenders.

The explosion of big data, ease of use for the business owner, and the increasing power of technology are likely to result in both the continued growth of the alternative lending segment and potentially new regulatory oversight. A handful of banking institutions have already announced partnerships with leading alternative lenders in order to harness the benefits extolled by the underlying processes, and many institutions are investigating how this new lending channel might support their client base. However, the issues of ongoing oversight and regulation, borrower protection, lending compliance, and transparency around loan pricing are gaining momentum and have resulted in numerous efforts to better understand this lending segment. RMA member institutions that provide financing in the small business segment will want to remain vigilant in monitoring both the growth of the alternative lending segment and the level of oversight that is continuing to evolve.

Small business lending remains a cornerstone for most financial institutions, but the pace of change is quickening and causing many to evaluate how best to serve the client. The competitive forces are causing many institutions to reexamine and redouble their efforts and to stay on top of the many challenges facing small business owners. Additionally, banks must consistently monitor the rapidly changing regulatory environment that may impact small business lending. Specifically, the following items should be closely followed:

  • Forthcoming small business data collection as outlined by Dodd-Frank Act section 1071.
  • Potential expansion of regulatory oversight of alternative/online lenders and the downstream implications for bank/fintech partnerships and alliances.
  • Enhanced scrutiny of fair lending and loan pricing practices within small business, particularly for clients that operate as sole proprietors
  • Increased focus on data accuracy and consistency, the types of data being used during credit evaluation, and closer examination of credit reporting practices (consumer and business).
  • Execution of consistent practices that lead to transparency throughout the entire lending process while maintaining strong risk discipline.

Please look for the final Industry Insight on Tuesday, September 20, The Data Gap Is Real.

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