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With consumer lending, residential mortgages and commercial real estate volumes declining, many banks are shifting their lending focus to small business, a segment that has been growing steadily in the United States during the century's first decade. As of June 2005, loan outstandings were $601 billion for 21 million loans. From 2002 through 2006, net-interest margins continually declined, squeezing the revenue contribution of these loans. Banks are looking at more efficient ways to originate higher loan volumes and maximize profitability of this product line. Small business loan origination vendors offer integrated, work-flow-based solutions that can dramatically reduce origination costs by eliminating manual processes and disparate systems. Several factors influence small business origination and key elements of robust small business loan origination systems (LOSs).
The U.S. Small Business Administration (SBA) and Community Reinvestment Act (CRA) define small business loans as term loans and lines of credit under $1 million. However, financial services institutions (FSIs) vary widely in their definitions of small business loans. Most banks use annual revenue size of the business as a determinant, with $5 million to $10 million as the maximum. As Exhibit I shows, small business loan outstandings increased continually from 2001 to 2006; the compound annual growth rate (CAGR) was 6.9 percent from 2001 to 2005, the last year for which detailed data is available from the SBA.
Small business loan volume grew at the more dramatic rate of 14.3 percent from 2001 to 2005, with most of the growth occurring in loans under $100,000. The SBA Office of Advocacy divides small business lending data into two categories: business loans of under $1 million and microbusiness loans of under $100,000. Exhibit 2 shows that the volume of microbusiness loans had strong growth, while the volume of loans $100,000 and greater was relatively flat.
Banks that wish to grow their small business loan portfolios are seeking ways to increase origination productivity for low-value microbusiness loans while expanding their ability to underwrite larger loans for small businesses.
Straddling the Retail and Commercial Lending Silos
Part of the challenge of adequately serving the small business segment is that the credit needs of small businesses vary widely. As shown by Exhibit 3, outstanding balances for loans under $100,000, …