By Jorge Sun, CEO and Co-Founder, LendingFront
When the economy is firing on all cylinders, taking a long-term approach to financial decision-making makes the most sense. From long-game investments to long-term loans, ROI comes from betting on future gains and future growth. But in an unstable economy, like the one we are experiencing right now, long-term financial commitments pose a higher risk, which the majority of the country can’t afford right now—let alone small businesses or community banks.
In times of great crisis, it’s impossible to predict whether a business will have the staying power to still be operating in five years’ time, making long-term investments less attractive. We also know that low Federal Reserve rates aren’t going to change much—according to the Federal Reserve, near-zero interest rates are likely to last until 2023. In this scenario, banks will have a harder time making money on loans, but profitability is still possible. It just requires a shift from long-term to short-term thinking.
Small Businesses Think Short-Term By Default, Shouldn’t You?
Focusing on short-term lending allows banks to do a lot more than just filter out long-term requests—it opens up a whole segment of customers that fall into this category by default: small business applicants.
Think of the loan a small business needs to replace a piece of expensive equipment or to purchase seasonal inventory. A substantial proportion of small business’ capital needs are short-term by nature. By taking advantage of the surge in small businesses seeking capital—and catering to their immediate needs—lenders can generate more leads, quicker returns, and more business in less time, accelerating approvals without incurring additional risk.
Here are a few reasons to capitalize on short-term small business lending opportunities—and how it can benefit both you and your small business customers in the process.
Short-term means lower risk
When the future is volatile, a short-term lens is the way to go. Instead of focusing on lagging indicators of credit-worthiness such as last year’s tax returns, it’s much more productive to examine what’s going on in the business right now. Basing lending decisions off of real-time cash flow and sticking to short-term agreements is the best way to reduce exposure and mitigate risk. And when it comes to managing smaller sums of credit over shorter periods of time, small business customers can be ideal targets.
Even in stable market conditions, small businesses tend to require \ smaller loans, and typically use them to fill immediate, short-term business needs. By sticking to the short-term, lenders aren’t settling for short-term small business customers, but tailoring lending processes to better fit small business customers’ business models—a mutually beneficial reward.
Short-term means higher margins
Short-term small business lending can also yield higher margins. With short-term loans to fill immediate small business needs, it’s actually possible for lenders to charge more, which in turn, offers more security and higher margins in the same deal— something rare in higher interest conditions. And with 34% of small business owners saying that their current cash on hand could only last a month or less, the need for immediate capital is real. By catering to these business’ short-term needs, lenders can make more money upfront than they would with longer-term loans—bringing both the bank and small business customers the immediate cash flow needed to survive.
Short-term means quicker returns
Instead of funding a long-term loan for five years, short-term lending allows banks to extend capital and limit exposure to only a few months. This doesn’t just mean that small businesses get credit faster, it means lenders get paid back faster, allowing for more profitability in less time. Faster returns makes it possible to extend more loans more quickly and increase lending volume without incurring undue risk.
Short-term means greater revenue
Automating the small business lending process can also play a role in opening up new revenue streams. For example, by minimizing manual processes and enabling auto-rejections or approvals based on your credit policy, loan officers can come to the same conclusion in less time and at a lower cost. Cutting out certain manual processes makes the cost of processing short-term small business loans proportional to the profit they produce—and can result in a new stream of revenue in the process.
As uncertainty continues to cloud the economy, adopting a short-term small business lending approach can be instrumental in creating favorable economics and counteracting today’s low interest rates. Lowering the bar for small business lending will help deliver reduced risk, higher margins, and quicker returns to mitigate the impact of the current crisis and help prepare more soundly for the future.