Online Lending Collaboration

How INTRUST Bank collaborates with Funding Circle

Banks can collaborate with FinTech and other firms in a wide variety of ways. INTRUST Bank is looking toward a shared purpose and vision to make a long-term collaboration work for everyone.

“We are looking for partners with like-minded philosophies, not just in terms of how to underwrite, but in terms of mission and vision and what they are trying to accomplish as an organization,” Brian Heinrichs, chief financial officer, INTRUST Bank.

The $5.1 billion community bank, based in Wichita, KS, is working with marketplace lender Funding Circle to help increase small-business lending. The bank is buying loans through the Funding Circle platform while beginning a study of how it might use the platform in its own market area.

“They share one of our tenants as a community bank, which is that we want to fund small business as an important part of the community and engine for growth,” Heinrichs says.

As a marketplace lender, Funding Circle makes loans to consumers and business funded by third-party investors. Investors purchase notes based on risk grades and terms they select. Funding Circle screens borrowers and assesses risks. INTRUST, like other investors, does not evaluate individual loans but purchases loans originated and serviced through the Funding Circle platform.

INTRUST spent more than two years working with Funding Circle and getting comfortable with how they underwrite and how they source credit. “Our due diligence was getting comfortable with their models, underwriting, systems, and processes,” Heinrichs says.

Even more than that, however, the bank liked Funding Circle because of the firm’s commitment to small business lending as a way to improve communities while helping the bank serve the small business lending market efficiently and profitably.

“We all want to make money, but we certainly have a bigger view of our place in the world, and so does Funding Circle,” Heinrichs says. “We can buy assets and loans in the secondary market all day long. But we want partners that tie into our mission and overall goals.”

Filling Credit Gaps

The opportunity for collaboration between banks and FinTech firms on lending seeks to address gaps in providing credit, especially to small businesses. The general consensus is that banks have not made small business loans in nearly the quantity envisioned when the Federal Reserve sought to stimulate small-business lending by setting low interest rates in the aftermath of the financial crisis.

“The data on the small business credit gap is limited and inconclusive, but raises troubling signs that access to bank credit for small businesses was in steady decline prior to the crisis, was hit hard during the crisis and has continued to decline in the recovery as banks focus on more profitable market segments,” writes Brayden McCarthy, head of policy and advocacy at Fundera, an online lending marketplace designed for small business.

A recent Federal Reserve study also suggests that small businesses still face gaps in available credit, which is now more often provided by large banks. “Large banks’ share of small business lending has grown, especially among the smallest loans. This represents a change from 20 years ago when small businesses relied more on a relationship with local community banks for access to credit,” said Randal Quarles, Federal Reserve vice-chairman for supervision, speaking March 26, 2018, at a HOPE Global Forum.

Small banks of less than $1 billion in assets hold 19% of loans less than $100,000, versus 60% two decades ago. Some 60% is held by banks with $50 billion or more in assets, with the remaining 21% held by banks in the $1 billion to $50 billion range.

Inefficient Lending Processes

Banks are underserving the small-business market because they are not efficient enough to make smaller loans in a cost-effective way, bankers, consultants, and online lenders agree. It takes about the same effort—for both banks and customers—to make a $100,000 small business loan as it takes to make a $1 million loan.

“The major reason for poor profitability is that for loans of under $250,000 (and especially for those under $100,000 which are the vast majority by number of small business loans) the operating costs of finding the Borrower, processing the loan application and of loan administration/review, are all very high,” a 2015 report on small business lending by financial technology innovators and commercial financial institutions.

Published by FinTech investor QED Investors and the financial services practice of management consultancy Oliver Wyman, the report’s observations on the state of FinTech lenders, banks, and their competitive advantages holds up well in 2018.

For the smallest loans, the most frequently cited reasons for the denying applicants were low credit scores and insufficient credit history, the Federal Reserve study shows. “Most banks have not figured out how to do a small business loans in an efficient manner,” Heinrichs says.

The process is difficult for time-pressed, small-business owners as well. Given the option to spend much less time for a fast decision, they will take it, even if the cost of the loan is higher.

Technology Collaboration

Hence the recent interest in collaboration between online lenders and financial institutions—the new technology and more efficient processes developed by online lenders enable banks to serve businesses they may not otherwise have as loan customers.

“While it remains to be seen how much banks adopt from the platforms and processes of marketplace lenders, it need not be that one player has to win for another to lose,” write Karen Gordon Mills and Brayden McCarthy. “What is clear is that in this second phase of the transformation of the online lending market, existing players need to be experimenting with new ways of integrating technology into their lending activity.”

Their 2016 Harvard Business Review working paper, “The State of Small Business Lending: Innovation and Technology and the Implications for Regulation,” provides a map of online lending models, their progress in addressing small-business lending, and the regulatory changes required for sound growth.

For its part, INTRUST is exploring ways it can use the Funding Circle platform to facilitate transactions for some of its customers in some of its markets. “Going forward we are looking at ways we can expand and use the technology and processes potentially with some of our own customers and in our geographic footprint,” Heinrichs says.  “We are in initial stages of discussion and nothing is concrete.”