With big banks pulling back from small and medium-sized business (SMB) lending in the wake of the global financial crisis, the market was ripe for someone else to fill the credit gap. Enter: alternative lenders.
While marketplace lending platforms and alternative finance players first surfaced to compete with traditional financial institutions (FIs), many large banks have now realized that collaborating with these companies is the way to better service SMBs — and without the added investment in developing proprietary systems.
As this trend unfolds, though, there is another player in the small business lending space that still stands to disrupt the industry even if it isn't grabbing as many headlines.
Community banks approved 49 percent of SMB loan applications in November, according to the latest data from the Biz2Credit Small Business Lending Index.
“Small banks process a lot of [Small Business Administration (SBA)]-based loans and, according to recent figures released by the agency, the current fiscal year has already seen a record amount of SBA lending,” explained Rohit Arora, Biz2Credit CEO, in a statement.
But small business lending is only one part of the banking puzzle. SMBs demand access to robust solutions, from mobile banking to advisory services.
According to FIS's “Performance Against Customer Expectations (PACE)” report, released last July, SMBs are becoming increasingly unhappy with the options they're offered at large FIs, and it's causing them to consider switching providers. Here, again, lies another opportunity for community banks to fill the void.
According to Brian Heinrichs, chief financial officer at community FI INTRUST Bank, community banks have a few strong points, including “relating to our customers, and understanding their business,” he recently told PYMNTS. “Community banks are much better positioned to provide personalized service to small business customers; large national banks simply aren't equipped or motivated to do so.”
INTRUST Bank recently announced it is also taking part in the trend of collaborating with FinTechs. The FI said earlier this month it would be working with Funding Circle and providing funds to be lent to SMBs through the online platform.
According to Heinrichs, working with alternative lenders means clients can gain “the best of both worlds” — something he said “refers to the bank's personal relationships with a customer and the knowledge and insight of the local community and marketplace, combined with the efficiencies and power of the technology [of FinTechs] to provide the speed and execution that the customer desires.”
It's a strategic move as alternative finance companies are also positioned to compete against community banks.
In July 2017, the Federal Deposit Insurance Corporation (FDIC) held a meeting with a group of community bankers which told officials about the competitive pressures they're facing from FinTechs. The FDIC's Advisory Committee on Community Banking offered a platform through which community bankers could highlight these challenges.
“I think these non-banks, FinTech-type opportunities are going to be the biggest threat to, especially, community banks going forward,” David Seleski, president of Florida-based Stonegate Bank. “There are so many services we offer to our clients, but there's also a threat from non-banks eating into our traditional profit area.”
As the community banking sector explores how to address the FinTech competitive threat, they're also facing headwinds from regulators.
Last November, more than 100 state and local chambers of commerce worked together to compile a letter to Congressional lawmakers urging them to lessen regulatory burdens on community banks to ease access to funding for SMBs.
“We believe Congress should develop common sense reforms for community, mid-size and regional banks, which would help empower Main Street businesses,” the letter stated. “We urge you to make such legislation a priority.”
The letter followed the Senate Banking Committee's introduction of legislation that would aim to provide such regulatory relief for community banks, lowering the threshold at which these FIs would be considered risky under existing Dodd-Frank rules.
“There is real understanding that if we don’t enable the banks, we are not going to have the small business lending we need,” stated David Hirschmann, U.S. Chamber of Commerce president and CEO of the Center for Capital Markets Competitiveness, in an interview with Reuters. “This is not a Wall Street issue; it’s a Main Street issue.”
Community banks, like large FIs, can struggle to fully meet the financing needs of the small business market.
“Traditional lenders face several challenges when meeting the needs of small businesses,” Heinrichs said. “They may be behind when it comes to technology and tools that can assist in making quicker decisions. They can be weighed down by a legacy underwriting model. For example, it may take as much time and effort to review a multimillion-dollar loan as it takes to analyze a request for a $20,000 small business loan. Regulatory requirements are a factor, in some cases.”
Recently, the Federal Reserve has also begun to explore community and regional banks' position in the small business lending arena.
The Fed released a report, “Community Banking in the 21st Century,” last October, which surveyed more than 600 FIs. While analysts found small business lending dropped by 2.2 percent in 2016, the decline was significantly smaller than that at larger banks, which reduced SMB lending by 5.1 percent.
The Fed noted community banks' ability to connect with SMBs as a key competitive asset of the industry.
“Close relationships between community banks and small businesses often present opportunities and incentives for collaboration in other areas,” the Fed wrote. “The above-mentioned findings suggest that the high-touch service provided by community bankers is often applied holistically rather than to specific product areas only. This interpretation is reflected in the comments of surveyed bankers who described their comparative advantages using phrases such as ‘connectivity,’ ‘the ability to respond in a timely manner to customer requests’ and ‘being a part of communities.’”
Heinrichs also emphasized this “connectivity,” and the potential for community banks' competitive edge to become even stronger when a FinTech collaboration comes into the mix.
“When you compliment the personal touches with technology, small businesses receive the attention, the service and the advice they desire, all of which allows them to quickly get back to running their business,” Heinrichs noted.