The demand is huge for small business lenders.
Even with the uncertain state of the economy in the U.S. and the lingering impact of a global pandemic, small business lender balance sheets continue to show strength. Loan origination is predicted to grow throughout 2022 and beyond.
And even though the number of new business applications jumped by two million from 2019 to 2021, many small business owners still struggle to find financing. If they do secure a loan, they walk away from their lending experience vowing to never go through the process again. This is largely due to outdated processes, long timelines, and high costs.
With so much demand, how can small business lenders position themselves to capture the activity?
There are clear common denominators among the small business lenders emerging on top in the current market. In this article, we will examine the best practices that separate a successful small business lender from the pack.
The State of Small Business Lending in 2022
To define small business lenders, most financial institutions categorize businesses across three market segments:
- Micro Enterprises. These businesses have less than $1 million in revenue and loans typically up to $250,000.
- Small Businesses. These are defined as having $20 million or less in revenue and $1 million or less in exposures.
- Middle Businesses. At the top are middle businesses, typically serviced by commercial banks. Middle businesses have aggregate loan exposure of anywhere between $1 million and $20 million.
Times of crisis in the past have hit small businesses hard, causing a dramatic decline in small business lending activity. The pandemic of 2020 could have been one more example, but the government assistance with PPP loans wrote a different story, creating an opportunity for small business lenders.
When in-person business came to a grinding halt in 2020, some small business lenders rose to the challenge by rapidly adopting digital processes as a matter of survival. This signaled the beginning of a shift throughout the entire industry to meet the changing needs and preferences of customers.
Yet most lenders are struggling to implement new strategies. The small business lending process at most banks is still a highly manual process, conducted across multiple unintegrated systems. The result? A small business lending operation that is inefficient, inconsistent, and expensive – culminating in a frustrating experience for entrepreneurs. For alternative lenders, this means the door of opportunity is open wide.
Despite challenges and struggles to adapt, small business lending continues to grow. According to the Federal Reserve’s Small Business Credit Survey, only 48% of small businesses overall had their financing needs met in 2018. Even then, over half of the firms who applied for $250k or less did not receive the full amount requested.
Challenges in Small Business Lending
Small business lending requires a different approach than lending for corporations. To evaluate credit worthiness, gleaning data from large corporations involves a much more straightforward approach. As Moody’s Analytics states, “most banks do not have effective systems and practices to accurately and efficiently assess small business risk and seamlessly conduct lending activities.”
Right now, small business lenders have an opportunity to fill the gap and address the funding needs of small businesses. Namely, by working with a cohesive, digital solution that can make the lending process seamless.
As noted above, many lenders are still resisting the process of digital adaptation. Instead, they cling to legacy systems that create challenges surrounding uncoordinated data sources and poor process design.
Effective and efficient lending practices are wholly dependent on the quality and visibility of data, and the process of evaluating and distributing funds. If either of these elements is lacking, the business suffers.
For small business lenders, this is especially true. But many still cannot provide the level of detail required to understand the drivers of success for the business. This leads to credit managers spending time trying to collect and analyze data from multiple sources. Once the data is collected, the standard credit score templates are tailored to big businesses, and require manual analysis of outside factors to determine risk for a small business.
The struggle doesn’t end there, as many small businesses may not have adequate financial reporting to facilitate continuous portfolio monitoring for their lender. If the beginning of the process is inefficient and manual, it continues to create costly challenges throughout the entire relationship.
Five Best Practices of Successful SMB Lenders
The demand for funding exists. The challenges for small business lenders have been clearly identified. Here are five best practices that you can implement to be a successful small business lender.
1) Establish a Clearly Defined and Communicated Loan Policy
What are your requirements for your most valuable lending relationships? Establishing a clear loan policy and ensuring your entire team is well versed in it is critical for your success.
Within your loan policy, be sure to address specific elements like:
- Risk tolerance
- Ideal portfolio makeup
- Any prohibited loans
- Approach to small business lending
- Underwriting guidelines
- Collateral/documentation requirements
- Credit authority and approval policies
Your sound loan policy should then be regularly updated and monitored by ensuring your loan portfolio is not deviating from what is stated in the policy. For example, one metric to monitor would be how many policy exemptions are granted within a given period of time.
Your loan policy is a high-level guide to ensure your risk tolerance remains in check. It also helps define the types of loans your institution is actively seeking. An up-to-date policy should reflect your financial institution’s needs, goals, and preferences, while also allowing for some flexibility to be effective.
2) Streamline the Collection of Borrower Information
Effectively assessing credit risk for small businesses can be a challenge. Often the business owner’s personal credit history is utilized as a determiner of creditworthiness and risk.
The more fragmented the data collection process, the more time it takes to assess. Manual data entry further extends the timeline and introduces human error into the assessment process. Multiply those challenges across hundreds and thousands of applications as you scale your business and the efficient collection of information becomes a huge drain on efficiency.
Small business lenders need more information than what can be provided through a manual process in order to make a responsible lending decision. Clean data is especially important for those small business lenders who don’t have years of historical data and established metrics for risk analysis.
Now reimagine your data collection as a streamlined process.
By leveraging digital solutions that automate most of the process, you can easily acquire and utilize information from multiple sources to make well-informed decisions.
3) Find the Best Way to Analyze Risk
There is no universal lending model. Determining your individual business objectives is paramount to making accurate risk assessments. Precise credit risk assessment is critical to your success as a lender.
But when data is thin (as it often is for small businesses) and credit history is lacking, how do you apply a traditional scoring approach? You can’t, at least not with an adequate prediction of success. Traditional credit scoring approaches may better serve corporate institutions, but an alternative risk analysis is required for small businesses.
Consider taking a modular approach and integrating data from multiple sources. Moving toward a rules-based scoring system can help small business lenders improve efficiencies and increase their bottom line.
It’s all about leveraging the data that’s available. With the right technology, you can integrate a business’ accounting software into your lending records to give real-time risk assessment throughout the relationship.
Once collected, deciding how best to weigh and score that data is equally as important. For example, a subprime lender may put little to no weight on a FICO score but care greatly about time in business, average daily balance, and annual revenues. Ensuring your technology allows you to write the rules based on your business model and your key clientele is essential for both assessing risk and scaling your business.
4) Learn From Data
Every decision as a lender hinges on data quality and visibility. Credit scorecards depend on factors uncovered from data gathering: data is necessary to identify the drivers of success in any loan operation.
Learning from data helps lenders:
- Respond to shifts in the market quickly.
- Scale their business across different markets.
- Adapt quickly to any regulatory environment.
- Understand what drives success in their business.
- Improve customer experience by increasing the speed and overall agility of the process.
- Foster better communication by creating a 360-degree view across all departments in an organization.
5) Embrace a Cloud-Based Approach
Legacy loan management solutions simply cannot deliver the data analytics required to be a top player in small business lending – much less provide the speed and agility needed to evolve with the industry.
Cloud-based solutions offer a host of benefits for small business lenders. They require no expensive hardware and little to no IT resources. Features such as regulatory compliance, data encryption, and disaster recovery are usually included in the overall subscription cost. The very best lending solutions provide a fully integrated platform giving lenders an end-to-end offering with real-time visibility into the data. And finally, users of the platform benefit from a modern and easy-to-navigate GUI.
In Conclusion
Small business lenders have an opportunity to grow their businesses and meet funding demands: following these best practices is the first step.
Onyx IQ is an all-in-one digital lending platform designed to help lenders automate their decisions and workflows. Ultimately, it helps you to close more deals more quickly.
Onyx IQ can help you implement every one of these five recommended best practices for small business lenders. Say goodbye to manual processes:, with our software you can quickly assess credit criteria, leveraging multiple data sources for truly actionable business insights.
Schedule your Onyx IQ demo today or reach out to us directly at info@onyxiq.com.
