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Home Business

Why Banks At Risk Of Losing Small Business Borrowers?

Editor by Editor
September 11, 2022
in Business
0
Small Business

Table of Contents

  • Biases In Banking And Credit Origination
  • Risk of inaction
    • Opportunity-cost
    • Banks Can Make A Difference To Small-medium Businesses
  • Rise of Fintechs and Alternative Financing
    • The Fintech Advantage
    • Alternative Financing
    • Reimagine Lending Business
  • Summing-up

Biases In Banking And Credit Origination

Lending is a risky business. Any lending institution provides access to credit for economic development. But things can be unfavorable, and even the best due diligence may fail.

After the financial apocalypse induced by the subprime crisis, regulations have increased to protect the integrity of the financial system.

Banks and lenders of the country have to follow Basel III guidelines to secure the financial system from irregularities that can compound systemic risk. However, banks developed biases and stopped thinking outside of the box. At times when the financial inclusion of small businesses was pertinent for economic growth, instead of embracing commercial lending software solution platforms, they backed mortgages and attracted high-salaried people with consumer loans.

Risk of inaction

Opportunity-cost

Incidentally, the period after the financial crisis in 2008 witnessed tremendous growth in the start-up ecosystem. Many companies that had a humble beginning in this period have succeeded and either merged with bigger companies or become stalwarts. Sadly, this was also the period when legacy banks shied away from investing in start-ups.

Investing in start-ups requires understanding the futuristic model of the business. The decision is based on factors that are beyond numbers and sales. Legacy banks reeling under regulatory pressure could not think beyond the box. Subsequently, a significant chunk of this market share was mopped by venture capitalists, private equity funds, and angel investors. Banks are late entrants into this market and still not the preferred route of a start-up as banks fail to act quickly.

Banks Can Make A Difference To Small-medium Businesses

Banks failed to recognize the potential of the small and medium business loans market. Small business owners cannot hire full-time accountants and business consultants. However, they are open to suggestions and are passionate about their craft.

Legacy banks will make tons of money by offering customized solutions to small businesses that allow them to charge a fee for value-added services like managing payment gateways, invoice-generations, bookkeeping, and tax filing services.

A win-win case for enablers and the end-users, value-added services will provide deeper insights into the business and allow banks to formulate customized small-business loans. The borrowers can employ the cash in their business and generate jobs to support the local ecosystem.

Rise of Fintechs and Alternative Financing

The Fintech Advantage

Necessity is the means for charging challengers to explore untapped business opportunities. Fintechs realized the gap between demand and supply of small-business loans and focussed on designing products that will service this segment. It used technology and embraced the concept of digital loan origination.

With solutions that focus on small business needs, fintech empowered them with easy access to credit. It tried to convert a bug in the financial system into a feature by offering paperless fast loans against the weeks taken by traditional banks.

These are some of the ways fintech companies revolutionized small businesses:

  • Offer value-added services like payment gateways for secure transactions
  • Accounting and tax services
  • Cash-flow management
  • Additional credit like easy to access overdraft facility and business credit cards
  • Data security
  • Business intelligence and client engagement consulting services

Metaphorically stated, fintech companies became the friendly-neighborhood superheroes for small-business owners. By taking advantage of the benefits, small-business owners focus on the core business as their forte.

Alternative Financing

Small business owners and start-ups lack access to easy and fast credit. Even if they meet the criteria for a loan, they have to apply well before time to avoid business-related hold-ups. If the loan is processed before the time they need, they have to pay interest for the period the loan was unused and idle. Even if founders of a start-up or small-business owners were farsighted about strategically planning the use of funds, they could not execute it with so many barriers.

Sensing the widening gap, in demand for credit and sluggish supply from traditional lending institutions,  a new category of alternative financing emerged in the last decade. Peer-to-peer lending platforms crowdsource the funds that are loaned to start-ups or small businesses. The revenue generated is distributed among investors after deducting operational costs and taxes. The benefits of P2P and alternative funds for small businesses include:

  • Aid scalability of business without equity dilution in the early stages of the company
  • Offers features like revenue-based financing incentivizing business owners to scale-up
  • Easy access to a variety of credit products like working-capital, bridge, or inventory loans
  • Business-centric loans that are not biased about the location or age of the founder
  • Round-the-clock digital presence and easy-to-access multi-channel platforms

Reimagine Lending Business

Three laggards to the success of traditional banks that have steered it away from a profitable segment like small businesses are :

  • Rise of fintech and P2P companies offering digital loans
  • Well-informed consumers who prefer AI-backed feature-rich products and solutions
  • Biases nurtured over the period by banks displaying risk-aversion without balancing parameters of risk and growth

Every dark cloud comes with a silver lining of hope; it is not different here. A recent article by a business consulting company states that banks are streamlining their small-business loan portfolio. Here are a few steps that banks have taken to increase their participation in SME lending:

  • Assess SME lending risks through data analytics and AI-driven financial modeling tools
  • Granular verification of information through automation
  • Integrating platforms to approach SME lending as a sum-of-parts analysis
  • Using the banking differentiator of developing the new platforms and integrating them with its economies of size and scope
  • Reduce the manual process and increase digital engagement with SME borrowers

Summing-up

Banks have an advantage like none other and can gain traction in any lending business as long as it is willed. Understandably, regulatory compliance is not just important but a feature that traditional banks pride in, however leveraging technology is the way to future growth. With backtested algorithms and scalable features, loan origination software, processes tons of applications without errors and in less than a few hours. This is the best time for banks to step up their credit model for small business loans. Changing their lending digitally can aid the optimization of resources and offer better insights to renew for future growth.

Tags: BankingLending institution
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