In response to a recent newsletter, a financial services executive emailed:

“I wonder if deregulation will enable the banks to profitably fund <250k transactions again?  

Do you think that banks will continue to do <250k deals or those will all eventually be outsourced?” 

The short responses: Not likely and more outsourcing will occur.

Of course deregulation will help. The current over regulation of banks negatively impacts small business lending and small businesses. Banks have come to avoid business loans that may survive solid underwriting but which examiners would classify on day one. And, capital requirements for small business loans are onerous, making attractive returns on these loans difficult if not impossible to achieve. As noted in prior newsletters, the credit box has narrowed.

While regulations are often problematic, the reticence of banks to lend to small businesses goes beyond governmental hurdles. They involve some fundamental business issues that regulatory relief will not address.

Why do we think more banks will work with a third-party to provide small business loans?

Bank approaches to this segment are cumbersome and costly. In a worst instance some banks underwrite small loans using the same manual processes as for larger loans, misaligning costs versus loan revenue potential. Too often (and even in recent days) I have heard a banker tell me: “We underwrite a $100,000 loan just like it is a $1million loan.” Other cost factors include unacceptable sales expenses due to a bank’s dependence on a small business sales force of relatively high priced personnel.