With the expenses of loan origination, underwriting, compliance and ongoing monitoring, it’s difficult for traditional lenders to make small business loans profitably. The costs to issue a $100,000 loan and one for $1 million are similar, but clearly, the interest earned on the larger loan is drastically greater. Which makes it no surprise that, despite an uptick in the number of businesses opening, banks have issued 20 percent fewer small business loans since the Great Recession, according to a 2014 Harvard Business School paper (PDF).
This profitability gap largely explains the rise in alternative lenders, who underwrote 22% of all small business loans last year – a figure that’s still growing. But thanks to fintech, it doesn’t have to remain that way. As we noted in a previous post In Fintech, the Smartest Disruptors Are Partnering With Banks, banks can successfully integrate tech platforms into their existing business structure — regaining market share, improving profitability dramatically and offering borrowers better, more affordable lending terms in the process.
Investing in Technology is Affordable
Taking your small business lending online can close the profitability gap – at a development cost considerably below what you might suppose. Many traditional lenders find outsourcing tech platforms makes the best sense for their needs, timetable and budget.
Financial institutions of all sizes prefer outsourcing for different reasons. Small banks can build and launch a customized online lending solution without any IT staff at all. Large banks may have IT departments of their own, but must compete with better-established, internal profit centers for tech resources. By combining an independent, affordable fintech cloud-based platform with their number one asset — their existing customer base — traditional lenders can originate loans more rapidly at much more attractive terms to borrowers, beating back competition from alternative lenders and saving a lot of money themselves in the process. The operational cost efficiencies are so considerable, in fact, that most banks will find their online lending platform pays for itself in just a few months.
What Banks Are Missing
Because of their many current customers, traditional financial institutions are sitting on a treasure trove of data. But without big data insights into the data associated with all those accounts, lenders must instead rely on costly manual processes and overly simplistic methods to analyze creditworthiness — losing customers and lowering profitability in the process.
Banks may reject a potential small business borrower because his PAYDEX score is just a few points below the threshold for approval. But predictive analytics could reveal more nuanced insights that change this assessment – for instance, a corporation with less than two years of operating history may actually be a long-standing, successful sole proprietor who finally decided to expand. Big data analytics can also help banks identify warning signs that a borrower is likely to default and intervene before anything detrimental (and costly) happens.
Fintech platforms already allow banks to automate and customize the loan process, providing the ability to weigh portions of an application differently according to their credit models and workflow. They also give banks the opportunity to create an expanded, more accurate picture of a potential borrower by incorporating additional data points like Yelp reviews and strong website traffic into account during the loan application process. Here’s where the ROI of your fintech investment really kicks in. By enabling a more nuanced and accurate picture of potential borrowers, lenders can expand the pool of creditworthy borrowers at limited – or reduced – risk, contributing to better long-term ROA. Add this to the operational cost efficiencies you can achieve, and the ROI on even a modest fintech investment looks very strong indeed.
Many financial institutions already outsource their retail banking businesses to third parties, offering customers a better online banking experience. Their next digital upgrade should be online lending – and technology investments concerns need not stand in the way. Banks can attract more creditworthy borrowers, wrest market share back from digital marketplaces, reduce operational costs, and make small business lending profitable. Fintech outsourcing is already empowering many future-forward banks. Will yours be among them?