The big gripe for small business owners nowadays is how difficult it is to get a small business loan. The days of community banks lending their neighbors a hand have been replaced by the skittish attitudes of big banks post-recession. But why, exactly are banks so timid about lending to small businesses? It basically boils down to three things:
1. It’s not cost-effective for banks
Beyond the fact that small businesses are riskier than established businesses, the truth is that smaller business loans are just not attractive to big banks. It costs banks the same amount of money to underwrite a $1,000,000 loan as it does to underwrite a $100,000 loan. However, the higher loan will potentially bring the bank more revenue, so it’s just not cost-effective.
Eighty percent of small businesses only need loans that amount to $500,000 or less, which means that 80 percent of small business loans are expensive for banks to underwrite, and don’t return a decent profit.
2. They rely on an old method of risk assessment
Many alternative lenders are sprouting up in the wake of the 2008 recession and are accepting small businesses with less-than-perfect credit scores. This is because they’re using big data to determine risk management. Alternative lenders crunch thousands of sources of data including social media profiles, shipping information, Yelp reviews and more to determine financial responsibility.
Because of stricter regulations, it’s hard for banks to innovate and start using information other than credit scores to determine risk. If you have bad credit, it’s much harder to get a business loan from a bank because they don’t use all the data that alternative lenders do.
3. Banks are stricter post-recession
Speaking of strict banking regulations, banks have become even stricter post-recession. Banks have to prove that they’re not taking on a lot of risky investments, and since small business loans are inherently risky, banks have to turn a lot of them down.
The interesting thing is that it looks like we’re starting to see a shift in the lending industry. According to Jamie Dimon, the JP Morgan Chase chief, there are some things that banks just cannot or do not want to do anymore, and those areas are where fin tech is taking the lead. When the dust from the Great Recession settles, we may be seeing banks and alternative lending companies partnering up to provide small businesses with a complete picture of financial services.