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Wednesday, September 23, 2015

Why Digital Lending Using Credit Reports and Deposit Volume Variables Is "Banker" Safe, Sound and Proven

 Bob Critchfield, past community bank Chief Credit Officer, CEO and industry consultant, documents one bank’s simplified underwriting framework for loan relationships under $50k that has served well for years with sound underwriting.   It is not "black box" lending, but uses variables where the bank has full control, but can be fully automated for efficiency and better service to customers.

Sample Community Bank Simplified 
Small Loan Underwriting Policy

Community bankers can document sound underwriting experience with full risk scope, governance, control practices and validation, such as the midpoint risk level of a population of small business loans just from credit score information on the guarantor as shown below.  This risk is further reduced with deposit and other information captured on borrowers.

Other digital lenders are stealing our bank customer revenue using sound underwriting.  The Wall Street Journal reports that PayPal is now doing $2 Million a day, and growing, providing loans up to $85,000 to small businesses.  It is the fastest growing part of PayPal’s business, and the loans are set up in minutes with underwriting based primarily 15% of the dollar sales volume processed by PayPal.  “We don’t ask for financial statements or tax returns but have sales patterns by week, month and year of processing volume through PayPal.  We can leverage that relationship in making sound loans,” said Darrell Esch, general manager of small business lending at PayPal.  

Some community bankers might say that PayPal and other tech firms are not using sound underwriting by not getting financial statements, tax returns and personal officer reviews for these smaller business loans.  Are they right?

If fact, many community banks have adopted a similar streamlined, sound underwriting process as PayPal for borrower relationships less than $50k.  They use deposit volumes to measure cash flow and ability to repay, along with credit report information to measure debt to income levels and risk.  Credit reports now have a 30 year history documenting risk with losses projected at 4% over the period.  Knowing deposit cash flow through the checking account can provide coverage ratio analysis of loan payments and further reduces loan loss risk.  Some community banks use 15% of deposits available for debt service just as PayPal uses 15% of its processing volume. 

Your bank has no lending relationship with 80% of its small business checking customers because it has not historically been profitable to pursue the market for loans under $50k which average $12k. Traditional underwriting and risk monitoring costs over $1,500 more than is earned in interest and fees on these loans, and more than three times the underwriting benefit of assuring 50 bps losses rather than credit card levels of 4%, or a $420 savings vs. the $1,500 added cost. Yet, 40% of all business loans are in this <$50k segment, representing $30 Billion loan revenue market,   This market is less than 1% of the total loan balances held by banks not affecting your ALLL, but in total represents revenue equal to 20% of the total industry revenue of community banks.

This approach to underwriting can now be further leveraged with secure, digital technology.  The best revenue growth opportunity you have is to provide efficient, low-cost delivery of small business loans with sound underwriting and risk monitoring using the digital lending technology of MinuteLender.

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