Are you a small business lender or about to step into the small business market? Maybe you’ve heard from colleagues that the small business banking space is fraught with dangers for the unwary. The purpose of this blog is to dispel some common misconceptions about small business banking. In honor of David Letterman who made countdown lists an art form, here are the top 5 fallacies of small business lending.
- Small business isn’t impacted by the economy.
Small businesses that have a tenuous hold on business dynamics fail fast in a recession. To survive a recession, many small businesses slow down expansion or halt growth all together. They wait for the return of consumer spenders before resuming growth plans, which means they stop seeking new or additional sources of credit and pay down debt. While small businesses weather the economic storm, you may see some shrinkage in your small business portfolios.
- Small business lending isn’t impacted by compliance.
Many small business lenders wish this were true! You need to know all of your regulators and your country’s regulations that govern small business lending. Develop strong partnerships with your internal compliance and legal departments. Consult with both groups before making any changes to your small business banking practices.
Don’t ignore consumer focused banking regulations that speak to individuals and how they are defined. Individuals own sole proprietorships and limited partnerships, so regulations specific to individuals may apply.
Many countries have regulations governing the following:
- Fair lending
- Privacy
- Data security and transmission
- Model management
- Permissible purpose
- Adverse action
- Risk-based pricing
- Capital allocation calculation
- Stress testing
If you are a multinational organization, be especially aware of home/host regulations.
- Small business lending is expensive and unprofitable
Small business lending is only expensive if you don’t have the right tools in place. You’ll need:
- A sound product strategy
- Lifecycle management
- Scores
- Automation to streamline costs
One of the best ways to control costs is to implement a data acquisition strategy to identify what data optimizes your decision making ROI by specific sub-segments within your decision making process. When you have low exposures, do you really need expensive business bureau data, particularly if the business in question is very small or very new. .
Assuming you have the right tools in place, your small business portfolio can be as much as 30 percent more profitable than your consumer portfolio. Your profitability will increase if you’re able to win the personal banking business of the owners and employees of your small business banking customers. Remember small business banking is grounded in relationship building.
- Small business banking is the same as commercial banking
Many unsuccessful small business bankers fail because they consider small business banking the same as commercial banking – just smaller. In reality, they have little in common. Small business banking is akin to lots of rolls of the dice with smaller dollar amounts at stake.
Many small business owners co-mingle their business and personal finances, so it’s important to evaluate the owners’ personal credit in support of data driven decisions. As much as 80% of risk identification can be found in the owner(s) information and this percent increases as the size of the business decreases!
The important lesson for small business bankers is that they too can take advantage of data, analytics, strategy development and evaluation, and automation to render the best decision at each stage of the lifecycle and to do so in a cost effective manner. Small business bankers should take the best banking practices from their retail shops and apply them to small businesses. When the exposure becomes larger, small business bankers can apply best practices learned from commercial banking to improve the decision making process and tighten their risk control by including judgmental components to their process but in a systematic and organized fashion.
And the top small business lending fallacy…
- Bankers need to see detailed audited financials, business plans and walk the property before rendering a decision.
About 95 percent of small businesses are truly small or very young. They’re fighting to survive while growing their business at the same time. Many do not have any type of financial statements to speak of, let alone accountants maintaining their books. Ask many small business owners to give you a business case, and you’ll get blank looks. They have no idea how to build one. If your organization requires multiple years of audited financials, business cases, branch managers paying on-site visits, etc. for your small business customers and prospects, you will need to be prepared to see your most creditworthy small businesses go elsewhere with their business. Would you require these time consuming and costly activities for a $20,000 consumer line of credit? Of course not, because it would take too long to make a decision. So, why would you require it for a $20,000 small business line of credit?
So what’s the answer? Automated credit risk assessment is the way to go. You may have some losses, but don’t lose sight of the bigger profitability picture. Low exposures allow you to control and price for risk and automation allows you to book as many viable applicants as possible.
Read our next blog on Small Business Lending: To Consumer Score or Not To Consumer Score
Are you a small business lender or about to step into the small business market and have a question? Please CONTACT US anytime, or for more information on training for Small Business Lending – check out: CreditLab: SME Fundamentals, LendingLab SME, CreditLab: SME