By: G. Michael Flores, CEO, Bretton Woods, Inc.
Not too long ago, it would have been heresy for a commercial bank to provide loan leads to non-bank lenders.
Since 2008, new compliance regulations, higher capital requirements and much tighter underwriting standards have caused banks to rethink the case of referring loan customers to alternative lenders. As a matter of fact, my firm has used a proprietary loan breakeven model to assist banks in determining their minimum loan amount that can achieve a targeted return on invest capital considering funding costs, direct, indirect costs, including compliance costs, and loan losses in originating and servicing consumer and small business loans. For many banks, $5,000 is the minimum loan amount for an individually underwritten consumer loan. Smaller requests are either handled by a credit card or home equity line of credit. For many consumers, their credit card lines have been reduced and the equity in their homes was decimated by the Great Recession.
Small businesses also face a dearth of credit options. For most banks, a very small minority of loan customers’ account for the majority of credit extended. These are the profitable customers where bankers spend their time and energy with these customers — the highest and best use of invested capital lie within this small group of customers.
The quandary then becomes how to provide service to customers who would be unprofitable in the traditional banking system. One answer is to refer these applicants to an alternative lender, such as Kabbage, Lending Club, Prosper, etc., many of who use non-traditional underwriting algorithms to qualify and price loans. These lenders also provide great service in that many requests can be approved and funded faster (sometimes within one day) than banks because of much more efficient processes and innovative technologies than the legacy processes and technologies that exist in commercial banks today. An example can be found today with the strategic alliance between Lending Club and Union Bank in San Francisco. However, while many of these peer to peer lenders are providing an important source of credit to consumers and small businesses that cannot qualify at commercial banks, they still do not adequately serve low income and underserved communities, primarily minorities and women.
A model exists in the United Kingdom called the “Bank Referral Scheme” where the CDFA (Community Development Finance Association) and five major banks work together to increase business lending throughout the UK. The scheme allows small to mid-size businesses that have been unable to get finance from traditional sources to access funding via CDFI’s with the aim of increasing business lending throughout the UK.
The answer in the United States is to strengthen both Community Development Financial Institutions (CDFI) and alternative peer to peer lenders by expanding the Treasury Departments CDFI Fund New Market Tax Credit Program to increase access to capital and reduce the cost of credit for underserved consumer and small business borrowers.
The NMTC Program is effective because it targets those hardest hit by the financial crisis; consumers and small businesses that would have few financing options, if any, were it not for the program. These are consumers and small businesses that put loan dollars to work immediately thus stimulating the economy. The statistics are compelling:
- For every $1 invested by the Federal Government, the NMTC Program generates over $8 in investment.
- Over 70% of NMTC investments have been made in highly distressed areas.
- Since inception, the NMTC Program has created or retained an estimated 358,800 jobs.
- 90-97% of NMTC business and real estate investments involve more favorable terms than the market typically offers.
It is my contention that this is a good public policy in that access to credit is a prime driver to accelerate our economic recovery.