With reports touting the health of the economy and the Federal Reserve talking about raising interest rates again, the lending environment must be good for small business owners, right? Wrong.
According to Babson’s 2016 State of Small Business in America report, obtaining capital is a challenge that frustrated SMB owners continue to face. Even those receiving a loan from a traditional lender obtain less than half the amount they applied for. They request a median amount of $100,000, but only get approval for $40,500.
What’s standing in the way of entrepreneurs borrowing from a traditional bank?
- Lingering fear from the Great Recession: From 2008 to 2013, small businesses benefited from loosened lending restrictions. But in the past couple of years, fears about SMB lending has shifted thinking and brought about a tightening of standards — leading banks to provide available loan opportunities only to bigger businesses, which they view as less risky.
- Fallout from Dodd-Frank: Post-2008 recession, new regulations created paperwork headaches for large lenders and small, community banks alike. But the annoyances aren’t just isolated to a potential borrower being required to fill out a couple of additional forms. Compliance increased the cost of originating loans, so much so that it’s no longer fiscally responsible for lenders to issue lots of small loans.In fact, Oliver Wyman research indicates underwriting these loans costs a marginal $1600 – $3200 per loan. Compare these costs to the annual revenue smaller loans generate – $700 to $3500 on average – and they’re clearly unprofitable.
- Fewer lending options: Another fallout from the large expenses associated with compliance? It’s expensive to raise capital to open new community banks. These local financial institutions are a great lending option for small business owners when big banks tighten their lending requirements. But with fewer local banks, SMB owners are left with fewer borrowing options than ever.
- The stimulus encouraged banks to stockpile reserves: Pre-2008, the U.S. economic structure encouraged financial institutions with large amounts of cash to lend it to other banks in need of liquidity. The federal stimulus packed reduced this cash flow, and large banks began sitting on large reserves — reducing the amount of available capital to smaller lenders (who would in turn pass it along to small business owners).
Despite these obstacles, traditional lenders can and should break the SMB lending logjam. According to Barlow Research’s 2016 Small Business Annual Report, SMB loan demand is downtrending slightly year-over-year: -9% between 2010 – 2016. However, this downtrend applies only to the traditional-lender space. New digital marketplace lenders are helping SMB borrowers to get around this credit logjam – and capturing more and more SMB lending business that used to go to banks.
According to one report by Morgan Stanley, loan origination at alternative lenders has doubled every year since 2010, reaching $12 billion in 2014. While banks still dominate as an overall credit source for small businesses, last year SMBs sought 22% of their financing from alternative lenders.
As we explored in the earlier post “Trouble for Marketplace Lenders Creates Opportunities for Banks — 3 Ways to Benefit,” alternative lenders are hardly the ideal solution for SMB borrowers. Digital marketplace loans offer SMB borrowers fast, convenient loans at a steep price, with expensive and often opaque lending terms that have attracted increasing scrutiny from regulators.
How can traditional lenders reverse this trend and break the SMB lending logjam?
Fintech players like Mirador work in conjunction with banks to make SMB lending faster and more profitable, to identify an expanded field of qualified borrowers, and to offer borrowers more affordable terms. Bringing small business lending online can dramatically reduce loan origination costs, improving profitability for banks while giving borrowers the speed and convenience they demand. Only when traditional lenders harness technology and big data will small business borrowers have access to the capital they so desperately need. Learn more in our white paper, Adapting the Best of Fintech to Small Business Lending.