Credit Unions & Small to Mid-Sized Banks Are Thinking About Digital Business Lending Technology All Wrong

Footprint lenders such as Credit Unions, Community Banks, and Regional Banks, by leveraging their greatest assets (i.e., low cost of funds, human relationships, and geographical/community ties to their borrowers) are uniquely positioned to compete and win in the highly competitive SBM lending arena against large national banks, fintech "disruptors," and other national online lenders.

Over the last ten years or so, there has been a dramatic paradigm shift in business borrowing behavior from offline to online financing transactions buoyed by the astonishingly rapid entrance of fintech "disruptors" into the market. The battle for SMB borrowers has become fierce. Long gone are the days when SMB borrowers would put up with the painfully slow process of seeking and obtaining often desperately need financing for their businesses. All else being equal, speed and ease of access to capital wins every time, particularly for small business owners. Many Online Lenders have emerged offering hundreds of thousands of dollars in business loans to borrowers in a matter of hours or even minutes, leaving smaller lenders such as sub $1b AuM Credit Unions and Small to Mid-Sized Banks relegated to the sidelines at worst and offering a frustrating, outdated customer journey for their borrowers at best.

All else being equal, speed and ease of access to capital wins every time, particularly for small business owners.

Large banks, fintechs, and online lenders (hereafter referred to as simply Online Business Lenders) have invested billions of dollars by some estimates and years of time (and brain damage) into building custom digital lending platforms or acquiring and integrating a fintech or tech-forward lender with its own platform, in order to keep up with and in fact influence borrowers' insatiable demand for ever more speed and ease to gain a competitive advantage.

Business borrowers strongly prefer the speed and ease of Online Business Lenders to the traditional loan application experience of Credit Unions and Small to Mid-Sized Banks, so much so that they will accept what could be argued to be predatory interest rates and repayment terms.

Business borrowers strongly prefer the speed and ease of Online Business Lenders to the traditional loan application experience of Credit Unions and Small to Mid-Sized Banks, so much so that they will accept what could be argued to be predatory interest rates and repayment terms.

This paradigm shift has changed the game for business lending forever. Whether or not to move to an online digital business lending platform is no longer a question. From a customer experience perspective, the statistics are irrefutable, to a greater extent each passing year and especially now given the COVID-19 crisis.

All is not rosy in Digital Business Lending Land.

While jaw-dropping advances in technology-enhanced business lending have changed expectations of borrowers, that effort and cost, practically speaking, has been met with mixed results in terms of ROI, portfolio performance, and arguably even the actual loans at the end of the dazzling application and funding process.

Many Online Business Lenders have taken their fair share of lumps with respect to severe diminishment in market capitalization due to lingering burdensome customer acquisition costs, massive technology spends, and generally abysmal credit performance. Meanwhile, an M&A buying frenzy among large banks of B2B fintech firms or smaller business lenders with seemingly robust online lending platforms has led to billions of dollars of investments in acquisitions and technology development with somewhat dubious results.

The story is unfolding quickly, but the fate of Credit Unions and Small to Mid-Sized Banks as small business lenders has not yet been authored. Indeed, all lenders must respond to changing borrower expectations to survive, but this story is like a "choose your own adventure" book. There are two adventures to chose from for Credit Unions and Small to Mid-Sized banks to author their own ending to this story.

  1. Freeze. Do not evolve, accept defeat and diminishing market share, and stick with business lending processes that are cumbersome and frustrating for borrowers and employees alike.
  2. Act. Seize the amazing opportunity that is being placed at their feet to deliver on their community banking "local" mission, delighting their local business customers and engaging their loan officers, analysts, and processors to a much greater level in their work.

As relationship and community-focused lenders, Credit Unions and Small to Mid-Sized Banks can win back their longstanding edge in small business lending.

Today, despite the challenges, large Online Business Lenders are winning and working hard to make Credit Unions and Small to Mid-Sized banks irrelevant in the business lending game.

This does not need to be the case. In fact, there's a very strong case to be made that Credit Unions and Small to Mid-Sized Banks are uniquely positioned to collectively dominate business lending in very important ways. A tremendous opportunity exists for smaller, more relationship and community-focused lenders to collectively regain their relevance and compete effectively against large online lenders to deliver on their "local" missions.

A tremendous opportunity exists for smaller, more relationship and geography-focused lenders to collectively regain their relevance and compete effectively against large online lenders to deliver on their "local" missions.

Technology innovation has evolved in such a way that all of the impressive bells and whistles and smooth UX (user experience) designs of Online Business Lenders are available to Credit Unions and Small to Mid-Sized Banks in the form of a highly configurable, "off the shelf," end-to-end digital business lending platforms that can be rapidly configured and deployed for a fraction of the cost of building the technology in-house or hiring a "platform" company to essentially custom build a digital business lending process. These innovations have also made this technology highly effective and affordable for smaller lenders. Let's break down the opportunity.

Broadly speaking, all business lending can be broken down into the same essential component parts, irrespective of loan product type:

  1. Onboarding (Initial or follow-on financing application)
  2. Underwriting & Loan Offers (data aggregation, verification, risk assessment, offer of terms, and documentation)
  3. Loan Servicing (disbursements, repayments, billing/collection activity)

Customer Onboarding & Initial Loan Application

Looking back over the last ten years or so, even with the major advances in digitization of the customer onboarding and initial loan application intake processes, the resulting customer experience has varied depending on whether the application was for a personal loan or business loan. With a high focus on delighting prospective borrowers, digital lending has evolved such that the process of applying for a personal loan is now seamless. Small business borrowers on the other hand have had a mixed experience due to the complexities and nuances of business lending, but on the whole, the application process for business loans from Online Business Lenders is rapidly becoming the preferred path for business borrowers seeking financing.

In a study by the Federal Reserve Banks regarding business borrowing behaviors and preferences, it was noted that 52% of small business borrowers were dissatisfied with the difficult application process of their bank. In contrast, with technology still not having evolved to today's standards, at the time of the study in 2015 only one-fifth of small business borrowers expressed the same dissatisfaction with their Online Business Lender.

Online Business Lenders offering a digital application process definitely have the edge over Small to Mid-Sized Banks when it comes to customer experience during the business loan application process.

Online Lenders offering a digital application process definitely have the edge over Credit Unions and Small to Mid-Sized Banks when it comes to customer experience during the business loan application process.

Underwriting & Loan Offers

With myriad data points for credit risk analysis digitally available from various data aggregators and bureaus, by leveraging technology, lenders can ingest and process a tremendous amount of information about a prospective borrower to instantly construct thorough business borrower and guarantor due diligence summaries. Online Business Lenders use this technology to drive super-fast credit decisions--and today's busy business borrowers want--scratch that--expect super-fast credit decisions.

That same Federal Reserve Banks study indicated that nearly half of business loan applicants expressed dissatisfaction with the long wait times for credit decisions from their banks. This is due to a lack of efficient processes, technology, and automation of the routine tasks of data gathering, file organization, and other highly manual processes distracting loan processors and credit analysts from spending their time on value-added activities. For online lenders, that dissatisfaction number was only 22%.

Credit Unions and Small to Mid-Sized Banks are taking far too long and wasting way too many resources making and communicating credit decisions.

Credit Unions and Small to Mid-Sized Banks are taking far too long and wasting way too many resources making and communicating credit decisions.

However, due to their go-to-market strategies, most Online Business Lenders are overly reliant on fully automated decision engines and pulling from various public data sources to inform their decisions. They can't really know their customers in the truest sense. Further, every such credit model relies on the stability of the underlying data to predict an applicant's probability of default (PD). Major economic events (think COVID-19) diminish the value of the underlying data points and credit risk is nearly impossible to accurately assess if a lender's customer is 1,000 miles away in a geographical location the lender is not intimately familiar with in the way a community focused lender would be.

So what does this mean for Credit Unions and Small to Mid-Sized Banks? They need to embrace a hybrid human and machine underwriting model that leverages technology for speed and human beings to understand the local nuance and intangibles of specific transactions, including the economic impact to and outlook for a very specific region at a very specific time and on a very specific business with very specific owners with which/whom the local lender is quite familiar).

Local lenders are uniquely positioned to match the credit decisioning speed of Online Business Lenders by integrating technology while beating those same lenders on credit quality and portfolio performance.

Local lenders are uniquely positioned to match the credit decisioning speed of online lenders by integrating technology while beating those same lenders on credit quality and portfolio performance.

With respect to loan offers, Credit Unions and Small to Mid-Sized banks have a huge leg up on Online Business Lenders. The Federal Reserve Banks study indicated that this is where the tables turn. Borrowers complained about unfavorable repayment terms (51% dissatisfied) and high interest rates and hidden fees (70% dissatisfied) received from Online Business Lenders.

It would be reasonable to conclude that Online Business Lenders had never in fact brought truly disruptive product innovation to market, but rather simply made the application process faster and more appealing for borrowers.

It would be reasonable to conclude that Online Business Lenders had never in fact brought truly disruptive product innovation to market, but rather simply made the application process faster and more appealing for borrowers.

There is a huge opportunity for Credit Unions and Small to Mid-Sized Banks to simply replicate the Online Lending application and decision experience, but couple that with more prudent risk assessments and superior underlying products. With their elevated cost of funds, lack of community connection, and excessive costs associated with borrower acquisition, today's Online Business Lenders simply cannot compete when it comes to credit quality, loan rates & terms, community connection, and portfolio performance

Loan Servicing

Disbursements and repayments are two areas of the business lending process where technology has played a crucial role in ensuring instantaneous credits and debits. Lenders today have the ability to assess repayment behavioral information in real time and react accordingly. In 2020, all business lenders, local or national, online or offline, should have this technology implemented. It goes without saying that streamlined servicing is important both for lenders and their borrowers.

While technology can enable lenders to generate models to predict and identify rising PD, feet on the street to visit borrowers and understand their situation makes all the difference in the world.

While technology can enable lenders to generate models to predict and identify rising PD, feet on the street to visit borrowers and understand their situation makes all the difference in the world.

When it comes to the management of delinquencies and recoveries, local lenders again have a leg up. Collection of payments from defaulting customers is most effective in a hybrid technology/human model and is most successful at the local level. It's hard to default and not cure, at least on a best efforts basis, when you possess a human relationship with your lender who operates and maybe even lives in your town--your local lender might even be one of your retail customers. Local lenders have the ability to work more closely with delinquent borrowers to come up with realistic repayment plans in a uniquely personal context.

It is time for Credit Unions and Small to Mid-Sized Banks to seize the opportunity!

Digital lending is here to stay and that is actually a very good thing. The key here is to thoughtfully leverage the advancements in technology to deliver a terrific borrower experience from end-to-end. Each "moment" in the borrower customer journey is an opportunity to delight your customer.

Credit Unions, and Small to Mid-Sized Banks are uniquely positioned in their communities to do this sustainably, with the highest level of customer care, and with the financial products business borrowers actually want. Local lenders have the ability to balance the amazing speed and UX that technology and automation can bring to the borrowing process (both for borrower and lender alike) with the uniquely human ability to build and maintain relationships, intake and assess softer borrower details that are impossible to break down into "zeros and ones," and stay close to their customers' evolving needs to direct the evolution of technology innovation effectively in the future.


Author

Richard Henderson is an equipment leasing & finance industry veteran and fintech expert leading growth for Capiform, a SaaS-based, comprehensive, fully configurable digital lending application enabling financial institutions to embrace the digital lending age at their own pace.