The Role Of SMB Lending At Community Banks Is Changing

Small business (SMB) lending is big business for community banks, which are a popular destination for small business borrowers, thanks to strong approval rates on loan applications. But new analysis from the Federal Reserve has identified a reversal in community banks’ position in the small business lending market.

The “Community Banking in the 21st Century” report, released by the Federal Reserve and the Conference of State Bank Supervisors last week, surveyed more than 600 community banks across the country and quizzed professionals at these financial institutions (FIs) about their approach to small business lending.

According to the report, small business lending at community banks dropped by 2.2 percent in 2016 down to $269 billion. That decline is contrasted by the 5.1 percent increase in SMB lending among large banks (FIs with more than $10 billion in assets) between 2015 and 2016 — and also by the fact that previous years saw community banks with higher loan origination volumes than large banks, researchers noted.

Small business lending also made up a smaller portion of community banks’ overall portfolios, from 16.6 percent in 2015 to 15.9 percent in 2016, due in part to a surge in commercial real estate lending activity.

According to the Fed, small business lending at surveyed community banks increased at its slowest pace of any other category of loans, while small business lending dropped among all community banks overall.

“These numbers suggest that community banks have lost some ground to bigger banks in small business lending over the past three years,” the report said.

How Community Banks Interact with SMBs

Despite the slumping SMB lending activity, small businesses represent a key focus for community banks, which told the Fed that their competitive edge exists in their ability to connect more efficiently with customers.

“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,” the report continued, “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.’”

But the survey from the Federal Reserve and the Conference of State Bank Supervisors found that community banks aren’t always providing additional services to their small business customers.

Nearly 100 percent of community banks surveyed said they either usually or always provide deposit services to their small business borrowers. Additional services are less common, however: Nearly a third of community bankers said they rarely provide long-term strategy advice to SMB borrowers, and while about 24 percent said they usually provide cash management services, 22.5 percent said they rarely do the same.

Nearly half said they rarely provide services to connect SMB borrowers to other customers or suppliers, while 46 percent said they rarely provide product development advice. Nearly 45 percent said they rarely provide succession planning advice to their SMB borrowers.

And while more than 20 percent said they usually provide general management advice, 31.5 percent said they rarely do so.

This data, the Fed noted, hints at a shift in the role of small business lending at community bank as the industry experiences evolutionary changes overall. Community banks face competitive pressure from a number of sides, including from big banks and FinTechs. But, according to the Fed’s survey, community banks consider their peer community banks to be the biggest competitive threat.

“With respect to small business lending, survey respondents … expect increased competition from FinTech firms, as well as from credit unions,” the Fed’s report stated. “This appears particularly inauspicious insofar as the volume of these loans contracted last year across the community banks industry.”

“The fundamental earnings model of community banks may be ‘sound,’ … but the role of small business lending within this model appears to be changing,” the report concluded.