I’ve spent much of my career in and around the financial services sector focused on small business banking. In the US, small business customers get bounced around like Goldilocks—they are too small to be of interest to commercial relationship managers and too complex to be easily understood by retail branch staff.
I applaud those banks that make a concerted effort to meet the financial needs of small businesses. After all, in the United States small businesses comprise 99.7% of all firms. (According to the US Census Bureau, a small business is a firm with less than 500 employees). In general, larger small businesses are better served as they use more banking products and generate more interest income and fee revenue than smaller small businesses. The lack of “just right” solutions for many small business financial problems has been a golden opportunity for FinTech firms.
In the FinTech space, much of the focus is on consumer-oriented solutions like Mint for financial management, Venmo for P2P payments, and Prosper for social lending. But FinTech companies figured out early on that small businesses weren’t getting the attention they deserved from traditional banks. Many of the top FinTech companies—Square for card acceptance, Stripe for e-commerce, and Kabbage for business loans, have gained prominence serving primarily small businesses.
Online small business lending by direct credit providers has especially taken off. Disruptors like Kabbage, OnDeck, and Lendio were quickly followed by more traditional players like PayPal, UPS, and Staples. Morgan Stanley reports that US small business direct lending grew to around $7.5B in 2014 and projects expansion to $35B by 2020. They also maintain that most of this growth is market expansion, not cannibalization of bank volumes. This makes sense—direct lenders usually attract borrowers that can’t get bank loans and charge accordingly. For example, Kabbage averages 19% interest for short term loans and 30% annually for long term loans. According to the Federal Reserve, the average interest rate for a small business bank loan (less than $100k) in August 2015 was 3.7% and current SBA loan rates range from 3.43% to 4.25%.
And that common wisdom that US banks have pulled back from small business lending? Let’s take a look at data compiled by the FDIC starting in 2010.
The overall volume of small business loans increased year-over-year from 2010 to June 2015, with a CAGR of approximately 3%. The total dollar value of small business loans outstanding dipped slightly in 2011 and 2012, reflecting slightly smaller loan amounts, a result of tighter lending standards. The facts are that US small business loan volume and dollar value outstanding are at their highest levels since the FDIC began collecting this data from banks. And by the way, there are almost 2,200 fewer banks in the US today than prior to Lehman’s collapse in 2008. Banks are happy to work with credit-worthy small businesses to meet their working capital needs. And direct lenders are happy to work with everyone else—-a win-win for all.