Why Banks Reach For The Unprofitable, Demanding SME

The dominating narrative in small business lending is the rise in alternative finance to fill the gaps left behind by traditional banks. Even so, FinTech innovators aren’t ignoring traditional FIs, with many developing solutions just for the banks to help them ease back into the game.

But the realities of small business finance remain: SMBs are often more risky than large corporate borrowers, and undoubtedly, they’re less profitable for the banks. So, it’s a curiosity why a bank and a FinTech partner would want to focus on the SME space at all.

Sageworks, which develops financial data management solutions for financial institutions, has just entered the SME lending arena with a new solution that provides banks with small business lending support. With its step in the SME lending door, Sageworks told PYMNTS why the stereotypical risk and lack of profits associated with small business finance don’t paint the whole picture for banks.

“Small business lending is an extremely important responsibility for banks,” the firm’s CEO, Scott Ogle, said in an interview. “The communities and local economies that they serve rely on this capital to succeed and thrive.”

This concept considers the role that small businesses play in their local and national economies overall. Indeed, it’s been repeated countless times: “Small businesses are the bedrock of the national economy,” and it’s an anthem that rings true for the U.S. and other markets.

Still, banks can’t heighten their small business lending volume for the good of the national economy. Financial institutions are themselves businesses, after all, and the bottom line is always in sight.

Ogle agreed that SMEs “can be considered a ‘low-profit’ line in the banking world.”

“These loans are relatively small sums of money that often take a disproportionate amount of time to evaluate and process,” he explained. According to Ogle, the resources required to process a $20 million commercial real estate loan, for instance, amounts to the same needed to process a mere $10,000 SME loan.

“The cost benefit isn’t great for some of these loans, because of the amount of money at stake,” he noted.

In today’s economic climate, however, there is a way for banks to profit from small business lending.

“Small business loans can be a high-volume, profitable and strategically important line if inefficiencies are eliminated at a bank,” the executive stated.

Small business lending among banks is on the rise, according to the latest data from Biz2Credit. Earlier this month, the firm published its most recent Small Business Lending Index report, which found an all-time high rate of small business loan approvals at big banks, reaching 23.5 percent in October — the seventh-straight month that banks have increased their approval rates.

In a statement, Biz2Credit CEO Rohit Arora said banks’ heightened willingness to lend to a small business is part of their efforts to boost bottom lines.

“Banks want to meet their targets for the year, which means the spigot of small business lending has opened up,” he said, adding that expectations for the Federal Reserve to increase interest rates is likely to add to the jump in SME lending operations among traditional FIs. “I expect to see even strong numbers,” he said. “Banks will try to fund companies at higher, more profitable rates.”

But the small business lending industry is complex. Despite Biz2Credit’s optimistic conclusions, Thomson Reuters and PayNet also published their Small Business Lending Index this month, and the report had less positive things to say about the industry. The index dropped to its lowest point since January of this year, while researchers also found that businesses are struggling to repay their loans — delinquency rates reached their highest since Dec. 2012.

The research makes it painfully clear that small business lending is not a certainty.

Sageworks’ Ogle, though, said there is another force at work that is driving banks to strengthen their SME lending game, even if some research says SMBs are more likely to default on repayments.

“Right now, business owners have a different set of expectations when it comes to accessing capital and interacting with traditional lenders,” he explained. “We’ve heard this countless times from the 1,000-plus financial institutions that we work with. Small businesses expect to be kept in the loop every step of the way, throughout the lending process.”

“They expect to be able to apply for a loan while sitting on their couches with their iPads,” he continued, adding that the rise in millennial-owned SMEs could be a driving force behind this.

The influx of alternative online lending marketplaces, too, has introduced a new expectation of convenience and accessibility for small business borrowers.

“The alternative lenders were born into this new world, and while they’re not replacing traditional lenders anytime soon, they are certainly on the cutting edge of the space,” the CEO said.

Regardless of the reasons behind the trend, Ogle said these kinds of demands are now “becoming the standard for the majority of business owners.”

And, according to Ogle, traditional banks are often “a couple steps behind” their alternative finance peers when it comes to meeting these expectations. So, while small business delinquencies may be up according to some researchers, demand for loans is also on the rise among the SME community. As banks continue to hold responsibility for meeting demand and supporting small businesses, they need all the help they can get to streamline their lending processes and make small businesses as profitable as possible.

With more complex needs among small business borrowers, too, working with third-party FinTech players could help banks stay on top.