By Brandes Elitch
Banking and Payments Consultant
I've heard a number of negative comments about banks recently: Big banks are saddled with outdated tech and a risk-averse culture. Banks are set up to prevent change and are hunting out change and trying to kill it. It feels like a dying industry. Banks focus on mortgages, loans and credit cards – balance sheet products. There's a disconnect between large lenders and their customers. Bankers are not incentivized to think about the customer in the right way.
In addition to the challenges expressed above, challenger banks and digital-only banks are focusing on the U.S. small and midsize business (SMB) market. Fiserv's recent 2020 Commerce and Fintech Outlook provides insight. Even though SMBs account for almost half (45 percent) of economic activity in the country, they feel "under appreciated and neglected" by their banks, according to the study. And only about a third of all SMBs surveyed believe their bank understands their business.
The 61 percent of SMBs in the study that use mobile banking report higher satisfaction than those that do not. This has created an opportunity for banks that do not need brick-and-mortar branches to target startups and entrepreneurs.
Recently, a local startup called Varo Money, which aspires to be a full-service bank, received final approval from the FDIC to obtain deposit insurance. In 2018, the Comptroller of the Currency gave them preliminary de novo national bank approval. This would make it the first digital bank to have a national bank charter.
In February 2020, LendingClub Corp. agreed to buy Radius Bancorp. This is the first time a U.S. fintech has formally agreed to acquire a bank. Radius has $1.4 billion in assets, making it a community bank. LendingClub has provided $12.3 billion in loans. Its CEO stated, "[T]his is a transformational transaction that allows us to reimagine banking in a way that is free from legacy practices and systems. …We create a category-defining experience for our members that will dramatically enhance the resilience and earnings trajectory of our business."
The banking world is changing. Private equity is focused on the payments system in a big way. According to Bain, buyouts involving payment companies from 2006 to 2019 have generated a gross pooled multiple of invested capital of 2.7 X, outpacing tech, financial services and the fintech sector. "The marriage of digital technology and connectivity is breaking down barriers to entry, and changing business models, as companies seek to bend a massive, inflexible system to the evolving needs of consumers and businesses," Bain analysts wrote. "Payments is an arcane, complicated business … merchant acquiring generates steady streams of fee revenue, but the business has become commoditized over time."
Private equity has played a major role in helping to build scale layers, often by carving out acquiring divisions from large banks, Bain noted, adding that the selling point is to offer SMBs a full range of tools and services that work in unison, so they don't have to stitch together unrelated products from different vendors, each requiring an investment in training and maintenance.
I once worked in corporate cash management for one of the largest banks in the country. The bank focused on large firms located in their target market (California) via a network of about twenty Regional Commercial Banking Offices (RCBOs). Each had a seasoned, highly compensated outside salesperson who knew every target market company in that region and conducted rigorous ongoing calling. The keystone was the bank's focus on a particular vertical (for example, agriculture, real estate) and the high legal lending limit.
When my salespeople, who supported half the RCBOs and all the branches in half the state, would bring a lead, the response always puzzled me. It was, "We don't know how to make money on a million dollar loan. It has to be bigger than that." I suspect this attitude hasn't changed, which is why there are always a few community banks with a billion dollars in assets in most cities here. If you are an ISO, find a way to partner with a community bank in your area, because their SMBs need your help and expertise.
I subsequently worked for a local community bank that focused on SBA loans. The problem was getting the SMB to fill out the SBA application. In almost every case, the local entrepreneur had never written a real, comprehensive business plan, which is an absolute requirement for an SBA loan. They had never written one because they found it overwhelming, which meant that I had to find a local small business consultant to write the plan for them, which usually took a month and cost a few thousand dollars.
The loan process was too difficult and intimidating for a small business entrepreneur. That hasn't changed either. The Fed reports that the average SMB spends over 25 hours on loan paperwork. An alternative lender can process an application in less than 30 minutes.
According to writer Chris Nichols, today's banks need a single boarding platform. It would include electronic signature, ID verification, a payments platform, data structuring and access controls. This should connect to a common database and allow access from the Cloud, an ecommerce site, a kiosk, mobile device, an order delivery service, etc. Banks typically write to and from their core processors, which would have to offer this connectivity unless the banks can find third parties to do so. That is where fintechs come in.
Borrowers do not relish filling out forms, but banks can populate them with information the banks already have (if the borrower is present) and augment it with information from AI and sources such as LexisNexis, Acxiom, Plaid, etc. Banks also need to focus on providing total solutions for borrowers, which include a deposit and transaction account, line of credit, commercial real estate financing, savings and money market accounts, receivables financing, and any other banking needs. Having access to all this data gives banks a better picture of the SMB's cash flow in real time, rather than just once every few months at loan reviews. This is a huge benefit from a risk management perspective.
Third parties can help community banks make it easier for customers to do business with them, and banks can often participate in the loan. Examples include Lendingclub, Prosper marketplace, Funding Circle and Upstart. These providers eliminate the traditional loan application process, and the SMB doesn't have to do all their banking with the lender to qualify. These lenders use alternative credit data, coupled with AI to analyze the ability to repay the loan. Other providers like FundBox and BlueVine can allow the SMB to use unpaid invoices as loan collateral. A big market exists for these upstarts. Challenger banks typically are established companies that seek to compete with banks. Neobanks are new entrants and are usually completely online or mobile. Talk abounds about this, but as I see it, most SMBs will want to use a community bank in their local area, particularly if they have a relationship with the loan officer. Community banks have a firm footing here. They will add APIs from various fintechs that meet their market needs, but they will remain firmly attached to their core processors.
Where do America's banks stand in all of this excitement? Last year the 5,177 federally insured banks generated $233.1 billion in net income (4,750 of those are community banks). Net interest margin was 3.3 percent. Loan balances continue to rise, asset quality indicators are stable, and the number of so-called problem banks is low at 51. The average net charge-off rate was 0.54 percent. A neobank or challenger bank would be hard-pressed to meet this excellent performance, assuming that they met and conformed to all the regulatory and compliance guidelines.
Community banks fill a vital need in even the largest cities, but they cannot afford to hire, train and support a staff to sell fee-based services, such as card processing, payroll, A/R collection, etc. Even a large bank will only use a cash management sales force for enterprises, typically with over $100 million in sales. This represents an ongoing opportunity for ISOs. Keep this in mind as you claim your territory. 
Brandes Elitch has been a cash management practitioner for several Fortune 500 companies, sold cash management services for major banks and served as a consultant to bankcard acquirers. A certified cash manager and accredited ACH professional, Brandes has a Master's in Business Administration from New York University and a Juris Doctor from Santa Clara University. He can be reached at brandeselitch@yahoo.com.
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