Are Bank Directors Worried Enough About Fair Lending?

Bank directors and executives, be warned: Federal regulators are focusing their lasers on fair lending. 

If your bank has not modernized its fairness practices, the old ways of doing fair lending compliance may no longer keep you safe. Here are three factors that make this moment in time uniquely risky for lenders when it comes to fairness.

1. The Regulatory Spotlight is Shining on Fair Lending.
Fair lending adherence tops the agendas for federal regulators. The Department of Justice is in the midst of a litigation surge to combat redlining. Meanwhile, the Consumer Financial Protection Bureau has published extensively on unfair lending practices, including a revision of its exam procedures to intensify reviews of discriminatory practices.

Collections is one area of fair lending risk that warrants more attention from banks. Given the current economic uncertainty, collections activities at your institution could increase; expect the CFPB and other regulators to closely examine the fairness of your collections programs. The CFPB issued an advisory opinion in May reminding lenders that “the Equal Credit Opportunity Act continues to protect borrowers after they have applied for and received credit,” which includes collections. The CFPB’s new exam procedures also call out the risk of “collection practices that lead to differential treatment or disproportionately adverse impacts on a discriminatory basis.”

2. Rising Interest Rates Have Increased Fair Lending Risks.
After years of interest rate stability, the Federal Reserve Board has issued several rate increases over the last three months to tamp down inflation, with more likely to come.

Why should banks worry about this? Interest rates are negatively correlated with fair lending risks. FairPlay recently did an analysis of the Home Mortgage Disclosure Act database, which contains loan level data for every loan application in a given year going back to 1990. The database is massive: In 2021, HMDA logged over 23 million loan applications.

Our analysis found that fairness decreases markedly when interest rates rise. The charts below show Adverse Impact Ratios (AIRs) in different interest rate environments.

Under the AIR methodology, the loan approval rate of a specific protected status group is compared to that of a control group, typically white applicants. Any ratio below 0.80 is a cause for concern for banks. The charts above show that Black Americans have around an .80 AIR in a 3% interest rate environment, which plummets as interest rates increase. The downward slope of fairness for rising interest rates also holds true for American Indian or Alaska Natives. Bottom line: Interest rate increases can threaten fairness.

What does this result mean for your bank’s portfolio? Even if you conducted a fair lending risk analysis a few months ago, the interest rate rise has rendered your analysis out-of-date. Your bank may be presiding over a host of unfair decisions that you have yet to discover.

3. Penalties for Violations are Growing More Severe.
If your institution commits a fair lending violation, the consequences could be more severe than ever. It could derail a merger or acquisition and cause a serious reputational issue for your organization. Regulators may even hold bank leaders personally liable.

In a recent lecture, CFPB Director Rohit Chopra noted that senior leaders at financial institutions — including directors — can now be held personally accountable for egregious violations:

“Where individuals play a role in repeat offenses and order violations, it may be appropriate for regulatory agencies and law enforcers to charge these individuals and disqualify them. Dismissal of senior management and board directors, and lifetime occupational bans should also be more frequently deployed in enforcement actions involving large firms.”

He’s wasting no time in keeping this promise: the CFPB has since filed a lawsuit against a senior executive at credit bureau TransUnion, cementing this new form of enforcement.

How can banks manage the current era of fair lending and minimize their institutional and personal exposure? Start by recognizing that the surface area of fair lending risks has expanded. Executives need to evaluate more decisions for fairness, including marketing, fraud and loss mitigation decisions. Staff conducting largely manual reviews of underwriting and pricing won’t give company leadership the visibility it needs into fair lending risks. Instead, lenders should explore adopting technologies that evaluate and imbed fairness considerations at key parts of the customer journey and generate reporting that boards, executive teams, and regulators can understand and rely on. Commitments to initiatives like special purpose credit programs can also effectively demonstrate that your institution is committed to responsibly extending credit in communities where it is dearly needed.

No matter what actions you take, a winning strategy will be proactive, not reactive. The time to modernize is now, before the old systems fail your institution.

Using Embedded Finance to Grow Customers, Loans

Embedded finance is all around us, whether you know it or not.

Embedded finance is a type of transaction that a customer conducts without even realizing it — without any disruptions to their customer experience. Companies like Uber Technologies, Amazon.com, and Apple all leverage embedded finance in innovative ways to create impactful customer engagements. Today’s consumers are increasingly used to using embedded financial products to pay for a ride, buy large items and fill in cash-flow gaps.

But the explosion of embedded finance means that financial transactions that used to be the main focus of customer experiences are moving into the background in favor of more intuitive transactions. This is the whole point of embedded lending: creating a seamless customer experience centered around ease-of use, convenience and efficiency to enable other non-financial experiences.

Embedded lending extends embedded finance a step further. Embedded lending’s invisibility occurs through contextual placements within a product or platform that small to medium-sized businesses (SMBs) already use and trust. Because of embedded experiences, SMBs can get easier, faster access to capital.

All of this could put banks at a disadvantage when it comes to increasing their reach and identifying more and more qualified, high-intent SMBs seeking capital. But banks still have compelling options to capitalize on this innovative trend, such as:

  • Joining embedded lending marketplaces. Banks can capitalize on embedded lending’s ability to open up new distribution channels across their product lines. Banks can not only protect their services but grow core products, like payments and loans, by finding distribution opportunities through embedded lending partners that match businesses looking for credit products and lenders on a marketplace.

Banks can take advantage of this strategy and generate sustained growth by using platforms, like Lendflow, that bring untapped distribution opportunities into the fold. This allows them to easily reach qualified, high-intent businesses seeking capital. Even better, their applications for credit occur at their point of need, which increases the likelihood they’ll qualify and accept the loan.

  • Doubling down on traditional distribution channels. Another viable growth strategy for banks is to double down on providing better financial services and advice through traditional channels. Banks possess the inherent advantage of being in a position to not only supply products and services, but also provide ongoing advice as a trusted financial partner. Incorporating additional data points, such as payroll and cash flow data or social scoring, into their underwriting processes allows banks to leverage their unique position to develop more personalized products, improve customer experience and better support customers.

Embedded lending platforms can aggregate and normalize traditional and alternative data to help banks improve their credit decisioning workflows and innovate their underwriting processes.

  • Reverse engineering on digital banking platforms. Banks can replicate this approach by embedding fintech products into their existing mobile app or digital banking platforms. Consider a bank that decides to provide shopping access through their online portals. In a case like this, a customer may apply for a car loan through the digital bank portal. The bank can then connect that customer to a local car dealership with whom they have a partnership — and potentially maintain revenue share arrangements with — to complete the transaction.

Lenders’ Crossroads Choice
Embedded finance’s effective invisibility of its services and products poses the biggest threat — or opportunity — to banks and traditional lenders. The convenience and ease of access of embedded financial products through platforms that customers already know and trust is an ongoing challenge traditional financial services providers. Yet embedded lending doesn’t have to be a threat for banks. Instead, banks should think of embedded lending as an opportunity to innovate their product lines and expand their reach to identify underserved small and medium-sized businesses in highly profitable industries.

Embedded lending opens a new world of underwriting possibilities because it relies on smarter data use. Platforms can pull data from multiple third-party sources, so lenders can efficiently determine whether or not a customer is qualified. With better data and smarter data use, fewer qualified customers get turned away, saving lenders time, cutting down underwriting costs and increasing conversion rates.

How to Find the Right Title Service Provider

In a highly competitive market, bank title service providers can have a tangible impact on business outcomes. Below are several considerations for selecting a title provider who can help institutions navigate today’s challenging market.

Stability
It’s important to know that the title provider your bank selects remains consistent, whether the market is up or down. Decades of experience, minimal claims and strong financial backing all contribute to the stability of a settlement service provider. “There’s an element of risk lenders can avoid by working with a title partner that has a history of producing instant title with minimal claims. How long have they been doing it?” says Jim Gladden, senior vice president of origination strategy at ServiceLink. “What does their track record look like?”

Service
Each file matters. After all, a home is likely your borrower’s biggest investment; making sure a purchase, refinance or home equity transaction goes smoothly is critical. For that reason, it’s important to ensure that title service providers take the unique needs of the bank’s team and borrowers into account, and prioritizes each transaction.

One way to do that is to work with a firm that dedicates individuals to working with the same lenders and loan officers, so they can understand the unique expectations each of them has, according to Kristy Folino, senior vice president of origination services at ServiceLink.

Prioritizing the Borrower Experience
The real estate lending industry is increasingly competitive; attracting and retaining borrowers is critical. Investigate how different title providers think about your borrowers, and whether their service ethos and technology prioritize the borrower throughout the transaction.

Check out the 2022 ServiceLink State of Homebuying Report to learn more about today’s borrowers. Dave Steinmetz, president of origination services at ServiceLink, says the study suggests a growing number of buyers embrace technology.

“Many are open to new pathways to achieve homeownership. This indicates there is an opportunity for lenders to provide more targeted resources and guidance to buyers throughout their home buying journey.”

Operational Efficiency
In leaner times, banks need to maximize margins on each transaction. Consider where your title service provider has automated their processes, and how that shows up in your bottom line. For example, instant title technology speeds decisioning and enables shorter rate lock periods by quickly clearing the way to the closing table. In fact, many lenders are surprised at how many of their loans qualify for fast-tracking through the instant title process.

Integrating technology and approaches like instant title into your processes could allow you to improve your workflows. Using instant title complexity decisions can help prioritize clear-to-close files, getting them to the closing table faster.

Scalability
In the past few years, the mortgage industry has seen how quickly volumes can change. In this volatile environment, it’s critical to partner with settlement service providers who can flex up or down with their financial institution partner as the market necessitates. The size of a provider’s signing agent panel impacts their scalability — as does their ability to allocate vendors to your operations at critical times, like month’s end.

Geographic Footprint
Being able to use one provider for transactions in all 50 states can simplify bank operations. Partnering with a title service provider with national scope ensures that a bank and its borrowers have a consistent experience, wherever they’re located. Gladden pointed out that national coverage is especially important for lenders with portfolios that are geographically diverse.

Security
Strict adherence to local, state and federal guidelines is critical to ensuring compliant transactions. Security around data must be airtight to protect lenders and their customers from potential breaches or other security incidents.

“Each title provider uses a platform that is aggregating both public and nonpublic consumer information. It’s important to know how that information is protected,” says Gladden.

Data quality
It’s important to look at the sources of title service providers’ data. While speed is essential, assurances from your title providers about data quality is paramount, particularly when it comes to instant title.

“The product is only as good as the data source, so the quality and depth of the data is the biggest factor to look out for. Instant title providers may all be racing toward the same goal, but the methodologies we’re using to get there — whether technologies, processes or the decisions we’re making — differ significantly,” says Sandeepa Sasimohan, vice president of title automation at ServiceLink.

Breadth of product offering
When you’re considering adding to your slate of providers, consider what value can be gained by onboarding a particular vendor. Banks that partner with organizations that offer a comprehensive suite of services — including uninsured and insured title products, flood and valuations — can benefit from increased efficiencies.

These considerations ladder up to one critical theme: partnership. Your title service provider should be a strategic ally who works alongside you to navigate market conditions.

3 Reasons to Add SBA Lending

There were nearly 32 million small businesses in the United States at the end of the third quarter in 2020, according to the Small Business Administration.

That means 99% of all businesses in this country are small businesses, which is defined by the agency as 500 employees or fewer. They employ nearly 50% of all private sector employees and account for 65% of net new jobs between 2000 and 2019.

Many of the nation’s newest businesses are concentrated in industries like food and restaurant, retail, business services, healthy, beauty and fitness, and resident and commercial services. This is a potentially huge opportunity for your bank, if it’s ready and equipped for when these entrepreneurs come to you for financing. But if your bank is not prepared, it may be leaving serious money on the table that could otherwise provide a steady stream of valuable loan income.

That’s because these are the ideal customers for a SBA loan. If that’s not something your bank offers yet, here are three reasons to consider adding SBA lending to the loan portfolio this year.

1. New Avenue for Long-Term Customers
Small business customers often provide the longest-term value to their banks, both in terms of fee income generated and in dollars deposited. But not having the right loan solution to help new businesses launch or scale means missing out on a significant and lucrative wave of entrepreneurial activity. That’s where SBA lending comes in.

SBA loans provide the right solution to small businesses, at the right time. It’s an ideal conversation starter and tool for your bank team to turn to again and again and a way to kick off relationships with businesses that, in the long run, could bring your bank big returns. It’s also a great option to provide to current small business customers who may only have a deposit relationship.

2. Fee Income With Little Hassle
In addition to deeper relationships with your customers, SBA lending is an avenue to grow fee income through the opportunity for businesses to refinance their existing SBA loans with your bank. It broadens your portfolio with very little hassle.

And when banks choose to outsource their SBA lending, they not only get the benefit of fee income, but incur no overhead, start up or staffing costs. The SBA lender service provider acts as the go-between for the bank and the SBA, and they handle closing and servicing.

3. Add Value, Subtract Risk
SBA loans can add value to any bank, both in income and in relationship building. In addition, the SBA guarantees 75% to 85% of each loan, which can then be sold on the secondary market for additional revenue.

As with any product addition, your bank is probably conscientious of the risks. But when you offer the option to refinance SBA loans, your bank quickly reduces exposure to any one borrower. With the government’s guarantee of a significant portion, banks have lots to gain but little to lose.

3 Ways to Drive Radical Efficiency in Business Lending

Community banks find themselves in a high-pressure lending environment, as businesses rebound from the depths of the pandemic and grapple with inflation levels that have not been seen for 40 years.

This economic landscape has created ample opportunity for growth among business lenders, but the rising demand for capital has also invited stiffer competition. In a crowded market, tech-savvy, radically efficient lenders — be they traditional financial institutions or alternative lenders — will outperform their counterparts to win more relationships in an increasingly digitizing industry. Banks can achieve this efficiency by modernizing three important areas of lending: Small Business Administration programs, small credits and self-service lending.

Enhancing SBA Lending
After successfully issuing Paycheck Protection Program loans, many financial institutions are considering offering other types of SBA loans to their business customers. Unfortunately, many balk at the risk associated with issuing government-backed loans and the overhead that goes along with them. But the right technology can create digital guardrails that help banks ensure that loans are documented correctly and that the collected data is accurate — ultimately reducing work by more than 75%.

When looking for tools that drive efficiency in SBA lending, bank executives should prioritize features like guided application experiences that enforce SBA policies, rules engines that recommend offers based on SBA eligibility and platforms that automatically generate execution-ready documents.

Small Credits Efficiencies
Most of the demand for small business loans are for credits under $100,000; more than half of such loans are originated by just five national lenders. The one thing all five of these lenders have in common is the ability to originate business loans online.

Loans that are less than $100,000 are customer acquisition opportunities for banks and can help grow small business portfolios. They’re also a key piece of creating long-term relationships that financial institutions covet. But to compete in this space, community institutions need to combine their strength in local markets with digital tools that deliver a winning experience.

Omnichannel support here is crucial. Providing borrowers with a choice of in person, online or over-the-phone service creates a competitive advantage that alternative lenders can’t replicate with an online-only business model.

A best-in-class customer experience is equally critical. Business customers’ expectations of convenience and service are often shaped by their experiences as consumers. They need a lending experience that is efficient and easy to navigate from beginning to end.

It will be difficult for banks to drive efficiency in small credits without transforming their sales processes. Many lenders began their digital transformations during the pandemic, but there is still significant room for continued innovation. To maximize customer interactions, every relationship manager, retail banker, and call center employee should be able to begin the process of applying for a small business loan. Banks need to ensure their application process is simple enough to enable this service across their organization.

Self-Service Experiences
From credit cards to auto financing to mortgages, a loan or line of credit is usually only a few clicks away for consumers. Business owners who are seeking a new loan or line of credit, however, have fewer options available to them and can likely expect a more arduous process. That’s because business banking products are more complicated to sell and require more interactions between business owners and their lending partners before closing documents can be signed.

This means there are many opportunities for banks to find efficiency within this process; the right technology can even allow institutions to offer self-service business loans.

The appetite for self-service business loans exists: Two years of an expectation-shifting pandemic led many business borrowers to prioritize speed, efficiency and ease of use for all their customer experiences — business banking included. Digitizing the front end for borrowers provides a modern experience that accelerates data gathering and risk review, without requiring an institution to compromise or modify their existing underwriting workflow.

In the crowded market of small business lending, efficiency is an absolute must for success. Many banks have plenty of opportunities to improve their efficiency in the small business lending process using a number of tools available today. Regardless of tech choice, community banks will find their best and greatest return on investment by focusing on gains in SBA lending, small credits and self-service lending.

Completing the Credit Score Picture

Traditional credit scores may be a proven component of a bank’s lending operations, but the unprecedented nature of the coronavirus pandemic has their many shortcomings.

Credit scores, it turns out, aren’t very effective at reacting to historically unprecedented events. The Federal Reserve Bank of New York even went so far as to claim that credit scores may have actually gotten “less reliable” during the pandemic.

Evidence of this is perhaps best illustrated by the fact that Americans’ credit scores, for the most part,  improved during the pandemic. This should be good news for bankers looking to grow their lending portfolios. The challenge, however, is that the reasons driving this increases should merit more scrutiny if bankers are accurately evaluate borrowers to make more informed loan decisions in a post-pandemic economy.

For greater context, the consumers experiencing the greatest increases in credit score were those with the lowest credit scores — below 600 — prior to the pandemic. As credit card utilization dropped during the pandemic, so too did credit card debt loads for many consumers, bolstering their credit scores. In some instances, government-backed stimulus measures, including eviction and foreclosure moratoriums to student loan payment deferrals, have also helped boost scores. With many of these programs expiring or set to retire, some of the gains made in score are likely to be lost.

How can a bank loan officer accurately interpret a borrower’s credit score? Is this someone whose credit score benefitted from federal relief programs but may have struggled to pay rent or bills on time prior to the pandemic and may not once these program expire? Compared to a business owner whose income and ability to remain current on their bills was negatively affected during the pandemic, but was a safe credit risk before?

There are also an increasing number of factors and valuable data points that are simply excluded from traditional credit scores: rent rolls, utility bills and mobile phone payment data, which are all excellent indicators of a consumer’s likelihood to pay over time. And as more consumers utilize buy now, pay later (BNPL) programs instead of credit cards, that payment data too often falls outside of the scope of traditional credit scoring, yet can provide quantitative evidence of a borrower’s payment behavior and ability.

So should bankers abandon credit scores? Absolutely not; they are a historically proven, foundational resource for lenders. But increasingly, there is a need for bankers to augment the credit score and expand the scope of borrower data they can use to better evaluate the disjointed, inaccurate credit profiles for many borrowers today. Leveraging borrower-permissioned data — like rent payments, mobile phone payments, paycheck and income verification or bank statements —creates a more accurate, up-to-date picture of a borrower’s credit. Doing so can help banks more safely lend to all borrowers — especially to “near prime” borrowers — without taking undue risk. In many cases, the overlay of these additional data sources can even help move a “near prime” borrower into “prime” status.

While the pandemic’s impact will continue reverberating for some time, bankers looking to acquire new customers, protect existing customer relationships and grow their loan portfolios will need the right and complete information at their disposal in an increasingly complex lending environment. Institutions that expand their thinking beyond traditional credit scoring will be best positioned to effectively grow loans and relationships in a risk-responsible way.

How Open Banking Will Revolutionize Business Lending

There has been much chatter about open banking over the last couple of years, and for a good reason. If it stays on its current growth trajectory, it could revolutionize the financial services sector worldwide, forcing changes to existing business models.

At this stage, many business bankers, and the small commercial clients they serve, are not ready to move to an open banking system. Banks have traditionally enjoyed a monopoly on their consumers’ financial data — and they do not want to lose it. Small business owners might worry that their data is shared with financial services providers other than their banks.

Open banking can seem risky, but it offers benefits to both lenders and borrowers. 2022 could be an excellent opportunity for this perception to catch up to reality and make open banking the norm in the business lending space.

Open banking is a banking practice that uses application programming interfaces (APIs) to give third-party providers access to consumer financial data. This access allows financial institutions to offer products that are tailor-made to consumers’ needs. This approach is more attractive than other ways that consumers have traditionally aggregated their financial data. For instance, screen scraping transfers screen display data from one application to another but can pose security risks. Optical character recognition (OCR) technology requires substantial human resources to read PDF documents to extract information. And data entry is both time-consuming and has a high likelihood of errors.

Using APIs addresses many of the problems that exist with other data aggregation methods. The data is transmitted directly — no need to share account credentials — eliminating the security risk inherent with screen scraping. And since there is no PDFs or data entry involved, bankers do not need to use many resources to check the accuracy of the data.

Still, bankers may wonder: Why do we need to move to an open banking system?

Business lending works today, but there is significant room for improvement. The main issue is the lack of centralized data. Lenders do not have enough data to approve loans to creditworthy borrowers or identify other products the client could receive. On the other side, small business owners endure a slow and cumbersome process because they must provide their data to each lender, one by one. An open banking system allows lenders to offer borrowers better terms and creates an easier application process for borrowers.

Misconceptions could complicate adoption. In an Axway survey, half of the respondents did not think that open banking was a positive development. They had concerns about the constant monitoring of financial activity (33%), losing control over access to their financial data (47%) and financial institutions using their data against their interests (27%).

But open banking gives consumers more control over their financial data, not less. Since open banking is a new concept, there is a significant gap between perception and reality. There is, understandably, a hesitancy among the public to share their data, which emerges when consumers are directly asked about it. But as services like Personal Capital and Credit Karma clearly show, consumers will overwhelmingly opt for open banking services because they can use their financial data to gain via more straightforward analysis or track their spending.

This is the promise of open banking in the business finance space. Small business owners want to focus their attention on non-administrative tasks and connecting their financial data to services that bring them faster access to capital with less paperwork is a clear benefit they are excited to get.

Services like Plaid and Envestnet Yodlee connect customer data directly with financial institutions and are widespread in the small business lending market. More than half of small business owners already choose to use these services when applying for financing, according to direct data reported by business lending companies.

Banks, on the other hand, will need to make a couple of adjustments to thrive in an open banking ecosystem. They will need to leverage the bevy of consumer financial data they have to offer more customizable financial products, as the system’s open nature will lead to more competition. To analyze all that data and provide those customer-centric products, banks should consider using a digital lending platform, if they aren’t already. Open banking is set to disrupt the financial services sector. Financial institutions can set themselves up for sustainable success by embracing the movement.

A Look Ahead to 2022: The Year of Digital Lending

2021 has been a year of challenge and change for community bankers, especially when it comes to lending.

Banks modernized and digitized significant portion of loan activity during the pandemic; as a byproduct, customers have begun to realize the inefficiencies in traditional lending processes. Community financial institutions that hope to stay ahead in 2022 should prioritize the incorporation of digital and automated loan processes.

Although the need to digitize commercial lending has long been a point of discussion, the Paycheck Protection Program (PPP) sparked a fire that turned talk into action for many institutions. Bankers quickly jumped in to help small businesses receive the funding they needed, whether that meant long hours, adopting new technologies or creating new processes. The amount of PPP loans processed in that small window of time would not have been possible without many bankers leveraging trusted technology partners.

One result of this approach was enhancing transparency and boosting efficiencies while helping small businesses at the same time. Many in the banking industry saw firsthand that, despite the commonly held belief, it is possible to digitize lending while maintaining personal, meaningful relationships. Bankers do not have to make a choice between convenience and personal connection, and we expect to see more institutions blend the two going forward.

Bankers also have a newfound familiarity with Small Business Administration programs following the wind down of the PPP. The program marked many institutions’ first time participating in SBA lending. Many now have a greater understanding of government guaranteed lending and are more comfortable with the programs, opening the door for continued involvement.

Embracing digitization in lending enhances efficiencies and creates a more seamless experience not only for the borrower, but for employees institution-wide. This will be especially important as the “Great Retirement” continues and bank executives across the country end their careers with no one in place to succeed them. To make the issue even worse, recruiting and maintaining technology talent has become increasingly difficult — even more so in rural markets. Such issues are leading some banks to sell, disrupting the businesses and communities that rely on them.

Partnering with technology providers can give institutions the bandwidth to effectively serve more small businesses and provide them with the customer experiences they have come to expect without increasing staff. Adopting more digital and automatic aspects in small business lending allows banks to reduce tedious manual processes and optimize efficiencies, freeing up employee time and resources so they can focus on strategy and growth efforts. Not to mention, such a work environment is more likely to attract and retain top talent.

Using technology partners to centralize lending also has benefits from a regulatory compliance standpoint, especially as potential changes loom on the horizon. Incorporating greater digitization across the loan process provides increased transparency into relevant data, which can streamline and strengthen a bank’s documentation and reporting. The most successful institutions deeply integrate lending systems into their cores to enable a holistic, real-time view of borrower relationships and their portfolio.

Community institutions have been a lifeline for their communities and customers over the last two years. If they want to build off that momentum and further grow their customer base, they must continue to lean into technology and innovation for lending practices. Developing a comprehensive small business strategy and digitizing many aspects of commercial, small business and SBA lending will position community banks to optimize their margins, better retain their talent and help their communities thrive.

What’s Driving Interest in Bank Primacy?

Becoming a valued client’s primary commercial bank — or primacy –– has been a hot topic during our daily conversations with bankers. At some point during those discussions, how to define and achieve primacy is bound to come up.

But primacy is not a brand-new concept. So why has it vaulted in recent months to the top of the to-do list at many commercial banks? We dug into the PrecisionLender pricing database to look for potential explanations.

The lending environment since the start of the pandemic in 2020 has not been a friendly one for bankers that build relationships purely around credit. Thanks to decreases in rates that weren’t always accompanied by similar declines in funding costs, the return on equity for credit-only relationships has declined more than 200 basis points in the past 24 months.

Cohort Group of Credit-Only Relationships

Profitability Trends

At the same time, deposits aren’t helping banks. In the previous market cycles, deposits were extremely attractive: They were a way to maintain, or even improve, spreads by lower funding costs. But right now, deposit costs aren’t really much lower than other wholesale funding options. Even though these relationships have experienced significant deposit growth in the past two years, that’s only been enough for banks to tread water when it comes to return on equity.

We then looked at a third group of commercial relationships. This group started off as credit only, but expanded to include both deposits and ancillary fee-based business. This group is the type of primary relationship that banks are now focused on winning: clients who keep a substantial portion, if not all, of their accounts with the same institution. The return on equity payoff is handsome – an average increase of about 190 basis points over the past two years.

Cohort Group of Relationships – Cross-Sell Growth

Profitability Trends

Bankers will often argue there are situations where it’s worth it to book a credit-only deal. We looked a variety of banks, from a wide range of geographies and asset sizes, and found that to be true — but only in a very select set of situations.

Credit-Only Accounts: Spread Over COF vs. ROE by Size



Depending on the bank’s targets for return on equity, small business loans can be profitable even without cross-selling other products or reservices. But as loan sizes rise and margins narrow, the return on credit-only relationships drops markedly. In some cases, such as Bank B, bankers may end up booking large loans that actually have a negative return on equity. But perhaps that relationship is only meant to stay credit-only for a brief time. Even if the return isn’t great initially, it can be worth it to land the initial, credit-only relationship with the hopes of expanding later, right?

In theory, yes. In reality, credit-only is not a temporary status for a considerable number of commercial relationships. Winning ancillary business takes time; sometimes it never happens. Nearly a third of credit-only relationships started between 2016 and 2019 have yet to add any non-credit accounts. We found 15% of relationships started more than 10 years were still credit-only today.

Credit-Only Incidence as of August 2021

By Relationship Start Date

In previous research, we’ve found that banks have historically failed to reprice credits over time, even when anticipated cross-selling opportunities did not materialize. This left the portfolio with underperforming relationships that dragged down performance for years.

The case for credit-only relationships gets even weaker when compared to broader relationships that encompass credits, deposits and fee-based services. Obviously, bankers know “broader is better,” but they not have realized just how much better these relationships are for the portfolio.

Credit-Only vs. Broader Relationships

Relationship ROE by Size of Credit Relationship



Taken together, this data explains why primacy is the topic du jour at many commercial banks. Simply lending your way past the stress that 2020 put on your bank’s portfolio isn’t an option; it can actually be a game of diminishing returns that could drag on for years. Adding deposits — something banks have had no trouble doing over the past two years — may only be enough to keep your bank running in place. To make a significant impact on the bottom line, your bank needs to achieve primacy through broader relationships with your most-valued clients. That’s why everyone’s talking about primacy now. But the smart banks are doing more than just talking; they’re adding processes and investing in technology to make primacy a reality.

Three Steps to Building a Commercial Card Business In-House

As the economy recovers from the impact of the Covid-19 pandemic, community banks will need to evaluate how to best serve their small and medium business (SMB) customers.

These companies will be seeking to ramp up hiring, restart operations or return to pre-pandemic levels of service. Many SMBs will turn to credit cards to help fund necessary changes — but too many community banks may miss out on this spending because they do not have a strong in-house commercial card business.

According to call reports from the Federal Deposit Insurance Corp., community banks make up half of all term loans to small businesses, yet four out of five have no credit card loans. At the same time, Accenture reports that commercial payments made via credit card are expected to grow 12% each year from 2019 to 2024. This is a significant strategic opportunity for community bankers to capitalize on the increased growth of cards and payments. Community bankers can use commercial cards to quickly capitalize on this growth and strengthen the relationships with existing SMB customers while boosting their local communities. Commercial credit cards can also be a sticky product banks can use to retain new Paycheck Protection Program loan customers.

Comparing Credit Card Program
Many community banks offer a branded business credit card program through the increasingly-outdated agent bank model. The agent bank model divorces the bank from their customer relationship, as well as any ability to provide local decisioning and servicing to their customers. Additionally, the community banks carry the risk of the credit lines they have guaranteed. In comparison, banks can launch an in-house credit card program within 90 days with modern technology and a partnership with the right provider. These programs require little to no upfront investment and don’t need additional human resources on the bank’s payroll.

Community banks can leverage new technology platforms that are substantially cheaper than previous programs, enabling issuers to launch products faster. The technology allows bank leaders to effortlessly update and modify products that cater to their customer’s changing needs. Technology can also lower customer acquisition and service costs through digital channels, especially when it comes to onboarding and self-service resources.

More importantly in agent bank models, the community bank does not underwrite, fund or keep the credit card balances on its books. It has little or no say in the issuing bank’s decisions to cancel a card; if it guarantees the loan, it takes all the risk but receives no incremental reward or revenue. The bank earns a small referral fee, but that is a fraction of the total return on assets it can earn by owning the loans and capturing the lucrative issuer interchange.

Bringing credit card business in-house allows for an enhanced user experience and improved customer retention. Community banks can use their unique insight to their SMB customers to craft personalized and tailored products, such as fleet cards, physical cards, ghost cards for preferred vendors or virtual cards for AP invoices. An in-house corporate credit card program gives banks complete access to customer data and total control over the user experience. They can also set their own update and product development timelines to better serve the changing needs of their customers.

Three Steps to Start an In-House Program
The first step to starting an in-house credit card program to build out the program’s strategy, including goals and parameters for credit underwriting. The underwriting strategy will establish score cutoffs, debt-to-income ratios, relationship values and other criteria so automated decisions reflect the policies and priorities of the bank. It is important to consider the relationship value of a customer, as it provides an edge in decision making for improved risk, better engagement and higher return. If a bank selects a seasoned technology partner, that partner may be able to provide a champion strategy and best practices from their experience.

Next, community banks should establish a long-term financial plan designed to meet its strategic objectives while addressing risk management criteria, including credit, collection and fraud exposures. It is important that bank leaders evaluate potential partners to ensure proper fraud protections and security. Some card platform providers will even share in the responsibility for fraud-related financial losses to help mitigate the risk for the bank.

The third step is to understand and establish support needs. These days, a strong account issuer program limits the bank’s need for dedicated personnel to operate or manage the portfolio. Many providers also offer resources to handle accounting and settlement, risk management, technology infrastructure, product development, compliance and customer service functions. The bank can work with partners to build the right mix of in-house and provided support, and align its compensation systems to provide the best balance of profitability and support.

Building an in-house corporate credit card program is an important strategic priority for every community bank, increasing its franchise value and ensuring its business is ready for the future.