Traditional Banks v. Alternative Lenders: How Goliath Can Beat David

Daily, I have been reminded by the government, that the signs of economic recovery are all around me. It certainly doesn’t feel that way, but it leads to an interesting discussion about economic change. Small business has always been the axiom of contributing factors to the success of the US economy. But in modern reality, the prevailing thought was that the economy had to be led by banks. The signs of change are around us, but it’s more likely that the US economy is rearranging itself rather than simply recovering under the old umbrella of Wall Street.

The rapid emergence of crowdfunding, alternative lending, and peer-to-peer transactions strongly indicates that small businesses are shifting away from the traditional banking environment. According to FDIC Data Calls as outlined in the Forbes, in the 4th Quarter of 2014, traditional banks’ commercial loan portfolios saw a 3.1% reduction, while alternative lenders experienced a 175% gain (FIGURE 1). Evidence that the economy was reinventing itself, and a new driving force is poised to guide the recovery.

Business owners simply stopped working with their banker, and the banker didn’t seem to notice – until now. I recently attended two banking conferences where the main theme centered on this topic. I found it interesting that each conference held round table discussion panels, giving equal status to the large traditional banks and much smaller alternative lenders. From an outsider’s perspective, the big banks are taking notice of the change as well.

This leads me to the question: “How does Goliath compete with David?” My answer, combine the best of both worlds. People still like to have the interaction with their “hometown” bank, but want the convenience of the website lender. Kyle Enger, known for his thought leadership in the world of relationship banking on the West Coast said it best, “Traditional banks have to embrace digital lending in their hometowns to compete.”

Here are a few ways Kyle described how this concept might work:

 Marketing to the local community and actively becoming a part of it

Business owners want to bank with someone they feel comfortable with and they can trust. Starting in their immediate area, block by block, farm by farm, bankers have to reacquaint themselves with their neighbors. In today’s fast-paced life, this means engaging with them through social media, as well as hosting educational events. An example of an educational event that would help propel a bank’s growth would be hosting a business owner seminar focused on helping people understand the dynamics of their company through the lens of their financial statements.

 Streamline the loan decision process by investing in technology

One of the most cumbersome and tedious processes a business owner encounters with a traditional bank is applying for a loan. It can be time-consuming and full of paperwork. Alternative lenders are on the rise mainly because they have automated this practice, eliminating the obstacles between a qualified borrower and their funding request. There are software tools that reduce loan approval times from weeks to hours. Employing any efficiencies in their process helps attract potential borrowers. It is simply human nature to follow the path of least resistance.

Improve relationship banking through education and advisory services

Lastly, traditional banks can improve their relationships with business owners by bundling non-traditional services with their bread and butter products. For instance, they could offer light advisory services or seminars to business owners who have working capital lines of credit. Topics could center on misfinancing, seasonality, inventory management, expense control and identifying the cash flow gap. Business owners are hungry for financial knowledge, and will thank you for it. As the owner of the relationship, the traditional banker should find ways to create more value for their clients that go beyond lending. Continued education satisfies that need, and can also be applied to the Community Reinvestment Act.

One of the best advantages that a traditional bank has over their more nimble competitors, is the actual cost of capital. Traditional lenders have access to their deposit accounts at virtually at 0% interest, and they can access additional federal funds at reduced rates as well. This isn’t the case for the alternative lender who can lend at a 1:1 ratio, with investor expectations as the prime contributing factor in their costs. So why haven’t banks fully capitalized on this clear advantage?

One of the reasons is the tendency of banks to be risk averse, and you can’t blame them. Traditional banks have taken a hit to their credibility, especially recently. According to a recent Gallup poll on “Honesty and Ethics in Professions,” the public’s view of bankers from a trust perspective has never been very high. It reached its pinnacle of 41% in 2005, before plummeting to an all-time low of 19% in 2009 (FIGURE 2).

There once was a time when you didn’t start a business without an accountant, a lawyer, and a banker. Recently, people don’t even consider a banker as part of the equation, or as an afterthought if at all.

Now is the time to change that perception. Since traditional banks have a better advantage when it comes to rates, they could increase rates to a level competitive with online lenders to offset the risks. Making the small to mid-market loans more financially viable. Furthermore, if a banker combines his clear cut advantage of having a lower cost of capital with the ability of getting to know the business owner – he holds the formula for turning a transactional relationship into an advisory partnership.

It is well known that in order for a smaller company to compete with a behemoth, they have to compete locally. Keep in mind the three critical components to competition:

  • High quality
  • Great service
  • Low price

The general rule is that you can have two, but not all three. For example, Ace Hardware competes with Home Depot by offering good products with better customer service, not necessarily at a better price. Banks could reverse engineer this strategy, and have their local branches act like independent small businesses. The difference is, they now also have a price advantage. Imagine a branch where you enjoy the benefits of a traditional bank loan, at affordable rates, serviced by a group you trust. If this could happen, the local community’s economy would strengthen and there would be no reason to seek out the financing help of the online lender.

Can the local banker in the traditional big bank compete with the high growth alternative online lender? The answer is YES, but they have to get to know their community more deeply and make it easier to do business. If you provide the value and make it easy for them to accomplish their goals, you have the winning combination to a life-long generational banking relationship.

Building the local economy one business at a time, strengthens the driving force of the American economy, creates local and regional jobs and promotes lasting wealth in each community. When this happens, the government can tell me the economy is recovered.

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Mike Milan is the Senior Vice President at Finagraph. With more than 20 years of entrepreneurial experience in his own business ventures and an array of others, Mike has developed a formula for crafting ideas into million dollar companies. After successfully selling his largest ground-up operation, Mike has consulted for large non-profits, small businesses, mid-size manufacturing companies, and hospitality-based businesses. His personal experience and involvement in the community combined with the technical knowledge of an MBA from Baylor University make for a powerful partnership.