Executive Summary: Many banks need to fundamentally rethink their approach to the small business space. Managers need to effectively address internal bank concerns about the segment while generating profits in ways that, for most, differ from the past.
The reaction to our recent newsletters on small business underscored that, at many banks, small business is in the doghouse, worldwide.
Bankers from both U.S. coasts, Canada, the UK, and the third world have all commented that their senior management is gun-shy concerning the small business segment. One wrote about high losses from the segment; another said that his bank is following a lending-oriented focus despite eroding profits from that activity; a third commented that a wide gap exists between the public relations hype that the bank uses to portray itself in its communities and the reality, namely, the bank’s reticence to embrace the segment.
Banks may think it is unfair but they are being raked over the coals in part because of public perception of their attitude toward small businesses. Both customers and the media believe that SMEs are being poorly served. Again, this phenomenon is worldwide. For example, the UK right-of-center newspaper The Spectator recently featured a cartoon as follows: a banker stands at the teller’s counter with his nose literally up in the air. Above his head are the words “You don’t have to be greedy to work here, but it helps.” At the counter stands the Chancellor of the Exchequer (the US Secretary of Treasury equivalent) with a drawn pistol and his arm around a small businessman; he says to the banker, gun drawn, “Give this small businessman a loan!” Readers could probably cite similar negative press examples from each of the 40-plus countries in which this newsletter is read.
No choice but to be in small business.
The fact is that most banks have no choice but to serve the small business segment and to lend to them. Why?
1. There are a lot of them in every community.
2. If pursued correctly (more on that later), SMEs represent a very attractive profit opportunity.
3. Going forward, opportunity areas for banks will be reduced, as per the forthcoming new financial regulation and consumer protection agency.
4. Just as the government pushed CRA lending, so too may the government “encourage” small business lending that goes beyond SBA-like activities. Banks that have been willing to be bailed out and protected by the government can expect to be asked explicitly to give more back in repayment.
Blame yourself not the small business customer.
Why have so many banks been disappointed by the small business segment? The answer is in the mirror, not the customer base. Many players failed to follow a disciplined approach to SMEs whether from a segmentation, product, or risk management perspective. And, most appear to have learned little from the past.
As for segmentation, banks failed to define the customer set that was most appropriate for them. Banks were not advisors or bankers but too often simply loan jockeys, slotting themselves (during the good times) into the role of commodity providers. They largely ignored the MAJORITY of small businesses that do not borrow.
The product most focused on was lending, despite its risk. One banker wrote to me that lending share was how banks kept score. The more loans, the higher the market share and the relatively easy ability to track progress against peers determined that bank’s focus. Today, banks continue to emphasize (mostly loan) products while proclaiming themselves to be trusted advisors.
Too many banks also relied upon “canned” models for credit decisioning. Note: in extraordinary times, credit models cannot be fully relied on for decisions. At a minimum, you need to develop proprietary models, as those lenders that invested in proprietary models appear to have outperformed others.
“If you don’t get a relationship, there is little profit.”
One very well respected colleague, a former banker who remains involved with the banking industry send me some reflections that perfectly capture the current situation in the industry regarding SMEs:
“Bankers still don’t get it… even in banks that claim to be ‘leaders’ in small business. Their approach is spotty – some regions get it, some play around it and some are lost. The lending emphasis is so interesting. Don’t they ever run the numbers? Take the average loan, calculate the gross revenue and then subtract all the cost: funding, acquisition, booking, service, collection and capital. What is left? Depending on the bank, not much. If you don’t get a relationship, there is little profit… Also, the cost of lending is increasing because of the failure of credit models to accurately score loans as evidenced by the Great Recession. Banks now must traditionally underwrite most loans even if they use a score as an indicator and further, they must devote far more resources to loan review and administration than in the past.”
What this expert points out is that the approach banks thought was working for them will not work going forward. Lending will be less profitable going forward: more touch as well as high tech, higher capital requirements (likely), increased government involvement, etc. Lending is only one part of the small business profit puzzle and is likely to be a smaller part in the future.
Where now?
So, how do you reboot your small business effort?
1. Determine how you arrived at where you are today. This is a basic step but usually one not followed by bankers that would rather not investigate the past. If your bank is not happy with its small business performance, specifically why? What went wrong? What are the lessons learned? What do you need to change going forward?
2. Offer gap. One of the reasons that banks continue to push lending is that they do not offer the capabilities that are truly of value to the small business: advice, cash management, investments, personal banking for the owner, etc.
3. Solution gaps. Banks know that most business owners want their banks to understand that their personal and business activities are pockets from the same pair of pants. Banks, encumbered by organizational models that are out of date and unresponsive to the customer, fail to react to this need…or simply do not care.
4. Build an economic case. Understand where the economic opportunities are going forward and where they less robust.
Concluding comment.
How do you convince management that small business is a great segment and that they should commit to it for the long term? Elements include: developing a frank assessment of the past; forming an objective view of the bank’s internal capabilities and gaps; and, quantifying on a pro forma basis the main profit pools from this segment. Those banks I know that have done well in small business have also had a leader who understood the business and could articulate a vision related to SMEs.