Are banks leaving SMB lending opportunities on the table?

As financial institutions look forward to setting their strategies for 2024, many are now working under the assumption that the elevated interest rate environment will be the new normal for the foreseeable future.

For the small business banking sector, things at first glance may seem particularly grim. A survey of senior loan officers by the Federal Reserve Board in May 2023 showed that nearly half of financial institutions are tightening loan standards for small businesses. Further compounding the issue is that in a higher interest rate environment, small business owners naturally become more reluctant to borrow as they recalibrate cost calculations and growth plans. 

And yet, even as small business owners are adjusting their plans in this new economic reality, they remain an attractive segment that banks should be courting. According to the US Chamber of Commerce’s Q3 2023 Small Business Index, 65% of small businesses say the overall health of their business is very or somewhat good, up from 59% last quarter.

While it’s become easy for many to point to the overall economy as an excuse to continue to shy away from the small business sector, it has created an immense opportunity for the financial institutions that have the vision and ability to step up to seize these attractive, larger deposits and build a high-volume, profitable SMB book of business. However, banks must first reevaluate their current technology capabilities.

The importance of having the right technology in place cannot be overstated when it comes to the ability to deliver on that vision.

Addressing the most common profitability chokepoints

Today’s financial institutions have a digital account-opening experience problem. While most institutions have mastered the initial application process, the majority still have gaps in their backend decisioning that prevent applicants from reaching a satisfactory conclusion to the loan process. Financial institutions must first address these gaps that are preventing them from delivering a superior customer experience. These profitability chokepoints come in various forms.

Firstly, manual processes need to be addressed. Higher application volumes require armies of employees to originate loans, creating friction-filled, daisy-chain loan origination experiences. This is not sustainable. On one hand, the cost per funding can’t be maintained at its current rate for high volumes. And on the customer side, current processes still ultimately rely on customers needing to come to a branch if something goes wrong in the process.

Another chokepoint is time. For many financial institutions, it still takes weeks to process a loan and sometimes years to launch a new program or product. Those that can’t keep pace will quickly lose out to their competitors.

Banks must also address the chokepoint of margin preservation. Imprecise credit decisioning increases fraud and default risks, eating away at profitability.

Lastly, banks face increased competition in SMB lending. New and existing customers have more choice in their financial services today than ever before, putting more pressure on banks than ever before to really differentiate themselves if they want their customers to choose them – and stay. 

Once these gaps are addressed, building and running a high-velocity SMB program can contribute to the overall health of the financial institution in a number of other ways. 

A key knock-on benefit that comes with a bigger SMB book of business are the deposits that usually come along with it. In a time when financial institutions are still skittish about bank runs and fleeing deposits, SMB deposits are arguably stickier, and in turn, safer. This can also help fuel additional product opportunities.

SMB lending also provides financial opportunities and an opening to deepen customer relationships across other consumer product lines, bringing more overall value to those deposits and opening up valuable cross-sell opportunities.

However, in pursuing a new SMB strategy, banks do not appear to be focusing on the bigger picture when it comes to technology, specifically in the origination process.

Arizent’s recent small business lending report found that 63% of respondents believed that improving the bank’s mobile app was the best way to improve the SMB customer experience. Additionally, 62% of executives thought improving security and fraud detection were vital to improving the digital experience. While those are important aspects of the overall experience, they do not necessarily address the chokepoints mentioned earlier.

Instead, banks are better served addressing areas that appeared to fall under the radar in the survey. Some 39% of respondents said they’ve applied automation to the onboarding process, which helps to reduce manual processes and improve upon fast and accurate loan decision. Thirty-one percent of respondents also focused on improving “underwriting for loans.” Ineffective loan underwriting is a significant chokepoint for banks.

Banks’ current mindset, at least according to the Arizent report, is focused on the wrong areas for improvement. Banks that overlook technology that improves underwriting and origination set themselves up to fail with SMBs in the long run, which is detrimental to both the financial institution and businesses that rely on access to capital to survive in uncertain economic times.

Where loan origination got overlooked

Though banks have made good-faith efforts to address these chokepoints, many of them are still missing the mark. Certainly, upgrades to mobile apps, improved marketing efforts, and revamped onboarding experiences help. But what will make a material difference to insulate banks from losing out against their competitors is a closer, honest examination of the origination process. The key question is, how quickly the bank can assess risk and deliver the loan to the SMB?

 This is the area we have seen banks most commonly overlook, and where the most opportunity is being left on the table. Until then, the rest is just superficial upgrades and marketing strategies. Nice to have, but far from needle-moving without addressing the opportunity to fundamentally improve decisioning within the origination process.