Community Banks Have Edge with Small Business Lending

A bank’s approach to small business lending varies by institution size, with small banks (community-based financial institutions) placing greater importance on relationship lending practices compared to larger banks, which privilege transaction-based methods. That’s just one conclusion drawn from a recently released Small Business Lending Survey conducted by the Federal Deposit Insurance Corporation.

For its study, the FDIC defined “small banks” as those with assets of less than $10 billion. Nationwide, 5,474 of 5,606 institutions fit the FDIC’s small-bank definition while holding, collectively, only 13 percent of the industry’s assets. In Minnesota, 262 banks have fewer than $500 million in assets; 18 banks have between $500 million and $1 billion in assets, and seven institutions have more than $1 billion in assets, as of the second quarter of 2018.

Majorities of small and many large banks use high-touch, staff-intensive practices to generate and maintain small-business loans, the FDIC found. Both large and small banks rely on customer referrals for new business. Small banks, however, were more likely to focus on community involvement and personal attention to build relationships.

Small banks typically have few managerial layers between owners and loan officers, therefore a loan officer may be more motivated to gather and use soft information when deciding whether to grant a business loan, the FDIC said. Small banks are considered more flexible and able to engage with small businesses on a case-by-case basis.

Small banks were more flexible in characterizing small businesses and engaging with start-up businesses than their large-bank counterparts. Small banks evaluated a wide variety of additional criteria to qualify startups for loans, including evaluating owner characteristics such as education or experience.

The vast majority of small banks with assets of less than $1 billion focused their C&I lending on small business loan customers, which were defined as businesses having C&I loans of $1 million or less. For its examination of C&I lending, the FDIC distinguished between banks with assets of less than $250 million and those with assets between $250 million and $1 billion. Of these banks, 86.4 percent and 76.5 percent, respectively, reported most of their C&I lending went to small business loan customers.

Personal residential property is an important source of collateral for small business lending, according to the survey. The acceptance of one- to four-family residential properties for collateral on small business loans is common and a majority of banks, particularly small ones, accept residential property as collateral for small business loans.

At small banks, commercial and industrial loans secured by residential property are an important part of their overall business loan portfolio. For banks with fewer than $250 million in assets, business loans secured by residential property make up nearly 15 percent of their C&I portfolio. For banks with assets between $1 billion and $10 billion, loans secured by residential property make up only 3.1 percent of their C&I portfolio.

The survey also reported small banks currently hold 42 percent of small business loans. Small businesses, meanwhile, comprise almost half of private-sector employment in the United States, said FDIC Chairman Jelena McWilliams.

The survey also showed that small banks more than large banks viewed credit unions as  significant competition for small business loans. More than one-third, or 34.1 percent, of small banks, viewed credit unions as a top three competitor, compared with only 12.2 percent of large banks. Fintechs, meanwhile, are viewed as competition mainly for large banks.

Additional survey topics included how banks operate within their markets along with an examination of competitive practices and advantages, as well as underwriting practices.

About 1,200 banks responded to the survey, which was conducted in 2016 and 2017.

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