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Small Business Is a Big Deal for Community Banks

March 22, 2018 by Neill LeCorgne

It’s time to leverage community bank strengths to boost small business lending.

U.S. small business lending is a $700 billion market, serving more than 29 million small business borrowers. And although community banks have lost substantial share of that market over recent years, they can recapture it. The keys to doing so profitably are:

  • Leveraging their strengths in relationship lending
  • Access to technology

The three major lending groups that currently serve small businesses are large banks, community banks, and a more recent entrant to the lending sector: online alternative lenders.

The upside.

Community banks—those with assets of less than $1 billion—have historically been a step ahead when it comes to fostering relationship-based lending. Their approach is typically characterized by local ownership, control, and decision-making.

In other words, relationship lenders can make lending decisions based on personally knowing the character of the borrower, the collateral, and the needs of the community.

The downside.

A number of factors have resulted in a limited availability of loan funds for small businesses—and a hesitancy on the part of community banks to expand small business lending. These factors include:

  • Limited resources compared to larger banks
  • Recent acceleration of merger activity in the community bank sector
  • Origination and onboarding inefficiencies resulting from the lack of up-to-date technology
  • A regulatory burden that is proportionately higher for smaller banks than for large ones

The average ratio of compliance expenses to noninterest expenses can be as high as 8.9% for banks with assets of less than $100 million. Compare that with 2.9% for banks with assets of $1 billion to $10 billion.

Consider how things have changed.

In 2010, commercial U.S. banks reported 19 million small business loans with an aggregate loan balance of $625 billion, according to data from the FDIC.

At that time, large banks funded more than three-quarters of the total number of small business loans and 61% of the aggregate loan balance. Community banks, meanwhile, reported 22% of the total number of small business loans, with an aggregate loan balance of $242 billion—or 39% of all small business lending by commercial banks.

Fast forward to 2016. Commercial banks altogether reported 23 million total small business loans, an increase of 4 million from 2010, with an aggregate loan balance nearly unchanged at just over $627 billion. However, large banks by this time funded 87% of total small business loans and 68% of the aggregate loan balance.

These figures represent important changes from 2010.

Small business loans funded by community banks dropped—both in number and aggregate loan balances. Indeed, community banks reported just 3.1 million, or 13%, of small business loans, with an aggregate loan balance of $199 billion, or 32%.

In recent years, online alternative lenders have also made inroads into small business lending. This group is highly innovative in their use of technology. And many borrowers are willing to pay the often higher rate these lenders offer in exchange for an easy application process, a quick decision, and rapid availability of funds.

As a result, online lenders have captured a rapidly growing share of lending since the financial crisis. In aggregate, the outstanding portfolio balances of these lenders have doubled every year since the mid-2000s. It is estimated that in 2015 online alternative lenders originated $5 billion in small business loans. While this amount represents only a fraction of U.S. small business lending overall, the rate of growth is notable.

For the full story featuring Sageworks, visit American Bankers Association – Small Business Is a Big Deal for Community Banks