By Tony Kowalewski, FICO
All over the world, governments are taking steps to drive economic growth by helping make more credit available to small and medium-size businesses. The Bank of England has shifted the focus of its funding for lending scheme (FLS) from the mortgage market to SME lending, while the Chinese government has issued a mandate for banks to increase SME lending while ensuring that they remain Basel compliant.
SME credit markets need to provide a sustained, reliable flow of credit for fuelling smaller business job generation, entrepreneurship and innovation. However, prospects for achieving this depend as much on improving lending processes as on government commitment and SME gumption. Too many small business loans are reviewed using lengthy processes designed for much larger businesses and loan amounts.
While SME lending is a growing global priority, unless creditors can make safe decisions quickly and cheaply, the cost of loaning to SMEs can be prohibitively high. Loan amounts are often too small for creditors to earn enough to justify a lengthy, costly originations process, but creditors must still make careful decisions because smaller businesses may be riskier than larger ones. Also, creditors must comply with regulations for accurately estimating capital risk reserves and treating applicants fairly, which apply to SME financing too.
This creates an awkward ‘catch-22’ — credit grantors will be able to expand access to SME credit in a sustainable way only if they can reduce the time and cost involved in current originations processes, which can’t be justified for smaller amounts of credit. Most creditors need to adopt or expand their use of decision automation, scoring and other analytics to overcome these hurdles. Using scoring and decision management technology can reduce the time needed to approve SME credit requests from the industry average of two days to as little as 15 minutes – removing many impediments to SME credit expansion.
Currently, in some Asian markets for instance, the time it takes to get answers to credit applications is a huge problem for business owners. Entrepreneurial opportunities emerge quickly and require action—often far too quickly for the slowly turning gears of classic bank originations. Even in cases where the business has an existing relationship with the bank, a decision can take weeks, as decision processes are rarely set up to facilitate analysis of historical data, especially across accounts.
SMEs are experiencing similar delays and frustrations in markets where credit processes have been largely automated for decades. Many US banks, for instance, reacted to the financial downturn by discontinuing automated decision-making, and stopping or reducing their reliance on small business risk scores. Qualifying for credit got tougher for all businesses but, according to a study by the Federal Reserve Bank of Cleveland: “while banks have loosened credit standards for big businesses during the recent economic recovery, they have maintained tight standards for small companies.”
Alternative sources of SME credit, including peer-to-peer lending networks and online/mobile finance companies that extend credit for a flat fee or a share of receivables, have rocketed. An increasing number of business owners find themselves in a situation similar to that of an entrepreneur who told his story to The Wall Street Journal – knowing his credit score had dropped during the downturn, he dreaded going through weeks of aggravation with his bank that might end in a rejected loan application. He opted instead for an online short-term lender, which wired the money to him within a few days. Opening the new branch soon afterwards, he was able to repay the principal and nearly 15% interest over the six-month loan term: "It's not cheap, but they served my needs quickly," he said.
In order to fight back, some banks are gradually reinvigorating their SME activity using a wider range of data and analytics, while following best practices that improve risk and compliance controls. As banks come out of retrenchment, alternative creditors face a tougher market, as they need more analytic sophistication in order to make sharper risk assessments that enable them to lower prices. Analytic insight is helping them to make better originations decisions as well as providing the risk transparency required in refinancing SME portfolios, thereby reducing the cost of funding. Even community banks and branches—where officers may know local businesses well enough to make quick, astute credit decisions themselves—can benefit from automated processes and scoring.
Our research over the last 20 years has consistently shown that the credit history of the business proprietor is a better predictor of SME loan performance than the information provided on a loan application form and the financial information about the business. However, analysing all three sources provides a pre-eminently accurate prediction of loan performance. Business owners seeking capital should ensure that they have managed their own personal credit well, and should check their credit reports for any inaccuracies.
Most SME creditors will have to combine speed and ease with personalised, business knowledgeable, relationship-based service. Analytics and decision automation enable creditors to shrink originations time and cost down to a level proportionate to smaller credit amounts, without giving up anything in risk management and regulatory compliance. With these tools, creditors can make careful, compliant originations decisions quickly and at very low cost. These are the means of offering smaller businesses speed, ease and relationship-based service across virtually any geographic footprint.
Tony Kowalewski is a client services partner at FICO, a global analytics software company. Prior to joining FICO 7 years ago, he enjoyed a 27-year career in risk management working for the likes of ABN Amro, M&S Money, Woolwich plc and Nationwide Building Society