Small business loans might be small in dollar amounts, but the SMB customer may be the most profitable customers to a bank. And yet, since the credit crisis, banks have not returned to meet the expanding need for SMB loans. This has paved the way for many fintechs to fill that gap, that is, until now.

“All of a sudden, banks are taking note of this space,” Trevor Dryer, CEO of digital underwriting platform Mirador, told Bank Innovation.

Banks have traditionally refrained from underwriting SMB loans because they are expensive, Dryer said. A typical SMB loan is $200K or smaller, but that still counts as a commercial loan, so for a bank, the underwriting costs, compliance costs, and risks are still high.

“It costs them about the same to underwrite a small loan of $200,000 as it does for a million dollars,” Dryer said. “So, banks are thinking, there aren’t enough returns.”

But viewing an SMB loan as a product is exactly where the banks are making their first mistake. According to Dryer, banks need to start looking at the small business customer comprehensively. “This dovetails with the trend of banks operating from a product-centric point of view to a customer-centric view,” Dryer said.

Jeff Brown, senior partner of banking and financial services at  consulting firm Genpact, agrees. “Individually the SMB customer is small,” Brown told Bank Innovation. “But collectively they are huge.”

Something similar happened in the SMB billpay sector a few years ago, Mirador’s Dryer said. “Banks were looking at billpay as a product, until one day Bank of America had an ‘ah-ha’ moment and started offering it as a part of their service suite, as opposed to charging it as a separate product.”

Each bill payment used to cost SMBs about $3 per transaction, he said.

A similar transformation needs to take place with SMB loans, both Dryer and Genpact’s Brown agree.

“Banks need to view SMBs as a whole picture as opposed to a product to product offering,” he Dryer said. “Because if a bank doesn’t underwrite the loan, then that SMB is likely to take its entire business somewhere else.”

And if that happens, it would cost the bank.

As Mirador’s Dryer explained, SMB customers tend to use the most banking products, such as small business credit cards, accounting services, and bill payment. The life of the relationship of a small business and bank is worth at least $36K in profit, Dryer said, making them “very profitable” customers.

The Solution
The issue with SMB loans from a bank’s perspective boils down to underwriting costs. Commercial loans carry higher underwriting charges, greater risks, and compliance costs. The solution, as is the case with many legacy banking systems, is technology.

“Using AI technology in the underwriting process is a huge advantage,” Genpact’s Brown said.

At Genpact, Brown works with larger banks such as Wells Fargo, but he has a deep-rooted background in small business financial services. He worked with startups such as PayCycle and Bill.com, which focus on accounting and payroll aspects of SMB.

AI underwriting should be seen not so much as a cost-savings play, he said, but as a leverage that frees up the underwriter to work on more complex loans. This is will increase the volume of loan originations for the banks, Genpact’s Brown said (in addition to reducing costs).

Machine learning in the application process to automate information is also a useful tool, Mirador’s Dryer said. Based in Portland, Ore., Mirador uses both AI and ML in its cloud-based underwriting service for banks. It also provides automated decisioning.

Their services can save a bank up to 60% of underwriting costs, he said. These technologies can also be applied to credit decisioning, Dryer said, which will only further lower a bank’s costs. Another fix AI and ML can help solve is time management. “Whether that’s response time, the application process or the time it takes for a SMB to receive the funds,” Genpact’s Brown said. “SMB customers shouldn’t have to wait two weeks to receive the funds.”

Fintechs in SMB Lending
To make this transformation, Banks have been turning to fintech comapnies. Take Mirador, for instance, which works with regional banks to digitize their SMB lending business.

But then, the SMB space has also given rise to fintechs that are working independently of banks.

Look at Redwood City, California.-based BlueVine. The company, which started in 2013, has already funded $900 million in SMB loans. Katherine Li, head of product marketing at BlueVine, told Bank Innovation that fintech lenders account for 22% of SMB loan applications. This number is only expected to grow in 2018 as the market for SMB loans is expanding consistently.

To illustrate this point, Li pointed to a 2016 Federal Small Business Credit survey that shows that 45% of small business owners in the U.S. applied for financing, and of that number, more than half (60%) were declined or received a smaller amount than requested.

“Fintech lenders can help bridge the gap, providing financing to small business owners who may not be able to get approved through traditional financing sources,” Li told Bank Innovation.

It looks like that is already happening. Banks — take note.