B2B Payments

How Banks Can Turn SMB Loan Rejections Into Opportunities

Disruptions to the small business banking and lending landscape over the last decade have completely overhauled entrepreneurs' relationships with FIs. Today, small businesses are often frustrated with their banks, and access to financing can be a challenge.

A survey previously released by the Federal Reserve found that small businesses face an 80 percent chance of rejection when applying for a bank loan. Separate analysis from FIS published last year found that bank switching among SMBs is a rising threat, with 14 percent of small firms having already ditched their providers for a competitor.

At the same time, big banks remain the top destination for small businesses in search of a loan. Alternative lending platforms, while emerging to fill the gap in small business bank loans, have yet to secure the same brand recognition and trust that centuries-old banks have garnered. For an entrepreneur faced with loan rejection, knowing where to turn next is crucial.

The president and CEO of the Association for Enterprise Opportunity (AEO), Connie Evans, wants small businesses to know that they have options if they are rejected for a bank loan. Just as importantly, she told PYMNTS, she wants banks to retain their relationships with SMBs even after the rejection notice goes out.

"Banks decline almost 8,000 applications for small business loans every single work day in this country," she said. "We think that's a real market failure."

The pullback of small business lending by large, traditional FIs has given rise to troves of alternative and marketplace lenders. Use of alternative finance is on the rise among U.S. small businesses, according to research from Mercator Advisory Group, but awareness remains low – nearly half of SMBs surveyed said they have never used an alternative lender. What's more, Mercator noted, there has not been any significant increase in the number of SMBs using alternative financing options between 2016 and 2017.

Separate data from Reliant Funding published last year found that only 12 percent of small firms had used some type of alternative finance.

SMBs in that survey cited the long wait of a traditional bank loan, lack of credit history and bank loan rejections as top motivators of their decision to use an alternative lender. But according to Evans, while these companies broaden SMBs' access to financing, they don't necessarily take note of financing type. In other words, small businesses don't just need a loan – they need a loan that is the right fit in type, size and funding source.

The AEO's latest initiative to address the funding gap for small businesses is the rollout of the myWay to Credit platform, announced earlier this month. The portal relies on referrals from banks that reject a small business loan applicant; SMBs are guided to myWay to Credit, where they are connected to community lenders like Community Development Financial Institutions (CDFIs) for funding.

The platform is reminiscent of the U.K.'s bank referral scheme, a regulatory requirement introduced in 2015 that has banks refer their small business customers to an alternative financing player when they have been rejected for a loan.

Evans noted that she watched the early days of this rollout, and acknowledged that the program is similar in objective to AEO's, as it ensures that banks don't necessarily lose a small business customer outright just because they cannot provide a loan to that client. Some U.K. banks are collaborating directly with alternative lenders to refer their clients to partners, lessening the competitive risk of this program.

"This is part of the problem we're helping banks to solve," Evans said. "Banks either don't have the right products or the right kind of guidance to provide these small businesses. So rather than just having to say 'no,' this is a way to have a more compliant, scalable opportunity to give businesses a second look.

"For the banks, it's a great deal," she said of lenders' participation in the myWay to Credit initiative. "They get to make a customer happy, and keep that customer."

For small businesses, of course, the referral program means a rejection stamp from the bank is not the end of the road in their search for financing. But according to Evans, it's not just access to a funding source that is important, particularly for SMBs in low-income communities that struggle to build credit. These entrepreneurs also need guidance.

Policy requirements, such as the U.K.'s referral scheme, "can make a lot of sense," said Evans, "so long as we have people who are reputable that can really offer the right fit."

Small businesses need to not only be matched to a source of capital, but also need mentors and a support system. Even if a small business isn't matched with a CDFI, the myWay to Credit portal still links them to guidance so entrepreneurs can progress toward access to capital.

Today's large banks are in a period of transformation when it comes to small business financial services. They face simultaneous competition and opportunities for collaboration from alternative lenders and FinTechs, and while they remain the top destination for SMBs in search of capital, they also remain a daunting source. A survey published this week by BMO found that more than a fifth of U.S. small businesses did not seek a bank loan at all because they feared they would be rejected – and nearly the same amount said they didn't apply because the process was too complicated.

"This truly is a changing landscape that banks are confronted with," said Evans. "The rise of FinTechs has created tremendous opportunity, as well as some challenges in terms of the quality [of] the service a customer is getting, and whether they're getting the 'right fit' capital to customers."

Amid this shift, however, banks are increasingly recognizing the power of technology to fill the small business funding gap, added Evans.

"Banks are beginning to recognize the use of technology to help them do more to meet customer needs," she said. "We want to make sure there is capacity on the small business side to be able to take advantage of these technology-enabled services. Having a network of both lenders and business service mentor organizations really is key in helping small businesses navigate the marketplace."



About: Accelerating The Real-Time Payments Demand Curve:What Banks Need To Know About What Consumers Want And Need, PYMNTS  examines consumers’ understanding of real-time payments and the methods they use for different types of payments. The report explores consumers’ interest in real-time payments and their willingness to switch to financial institutions that offer such capabilities.