Competing for Consumer Loans Through Collaboration


If the economy’s backbone is small business, then small business’ backbone is community banking. Unfortunately, both economic and policy developments have dealt community banks a sustained blow from which they can only recover together. The challenge is for community banks to leverage the scale they lack as individual institutions but jointly possess.

The indications of stress are stark. It was just a generation ago that community banks accounted for nearly 80 percent of consumer loans. The number today is less than 10 percent. The largest banks are simply driving community banks out of the lending business.

The irony is that some of the difficulty community banks face actually results from policies intended to help them. Regulations that were supposed to limit the largest banks instead created impossible compliance burdens for small ones. The lifting of limits on interstate banking gave the big players a further leg up. But the biggest challenge has come from the shift of many types of lending away from relationship-based, customized lending (at which local banks excel) towards process-based, standardized lending (which requires scale to afford the systems, people, models, marketing and processes that are required).

This evolution from handshakes in a local bank to anonymous clicks in online applications required massive investments in technological platforms that community banks were unable to make. Yet despite the pressures, community banks retain advantages with which no large bank can compete: the trust and genuine loyalty of local customers, a personal understanding of their needs and the willingness and ability to customize their offering to the specific needs of customers when appropriate.

But if they are to survive, personal service alone will not be enough. If these banks lose the ability to offer the broad array of products and services that have become process-intensive (consumer lending, small business lending, wealth management, etc.), they will lose their connection to their customers who are forced to look elsewhere. Community banks must combine what they are uniquely good at with the scale necessary to go toe-to-toe with the largest banks. The good news is that these banks, collectively, already have that scale. Taken together, community banks command $2.3 trillion in assets—14 percent of the economy and more than enough to compete with any of the largest banks.

“Together” is key. The imperative for community banks is to find ways to take advantage of their combined scale while retaining the local focus and service for which they are legendary.

One such model is BancAlliance—a collaboration, as the name suggests, of more than 200 community banks with more than $300 billion in assets in 40 states. That $300 billion would be enough to rank these institutions together as one of the 10 largest banks in the country. The network is managed by Alliance Partners.

Among other benefits, partnerships like BancAlliance can help community banks seize the opportunities in the financial markets that new technologies enable. New players like Lending Club are using high-end online platforms to provide first-in-class customer experiences that are taking ever larger swaths of the consumer lending business away from the largest mega banks.

The platforms are so sophisticated, though, that no single community bank has the resources to figure out how to forge a partnership with them. By partnering through collaborations like BancAlliance with lenders like Lending Club, community banks can combine their knowledge of their customers with the new lenders’ unmatched customer experience platforms. BancAlliance, for example, is allowing its members to achieve those benefits through a partnership under which the Lending Club platform is offered through community banks.

BancAlliance is a promising model for collaboration, but only one. Regulators are recognizing and encouraging the value of these efforts, even as tiered requirements and limits on consolidation are also improving the policy environment. The key to these collaborative efforts now is that community banks realize the value of their combined scale.

Community banks still have the best advantages in a business that ultimately distills to relationships and trust. But the detriments of smaller individual size have begun to erode those assets and, absent action, could threaten the sustainability of the community banking model. By joining forces—collaborating with each other and partnering with institutions that can give them access to the advantages of technology and reach—community banks can convert a serious problem into a compelling opportunity. And history tells us that when they are able to compete on a level playing field, community banks prevail.

Serving Up Kabbage to Small Businesses, with a Side of Technology


small-business-7-30-15.pngOne way to look at Kabbage is that it’s a company of mostly millennials who are helping to recreate finance in their own image. Formed in February 2009 during the waning months of the Great Recession, when many commercial banks had curtailed their lending and some were taking capital from the federal government to strengthen their balance sheets, Kabbage provides unsecured consumer and small business loans through its online platform. It is one of the leading players in the emerging fintech sector, and to date has made over $550 million in loans.

Neither Chief Executive Officer Rob Frohwein nor the rest of his leadership team are millennials (the company does have a sense of humor, playfully describing the team on its website as the “heads of Kabbage”), but there are plenty of them working at the company. And if you’re going to hire millennials to work at a fintech company, you’ve got to offer them cool stuff like daily catered lunches and snacks, on-site yoga, top-of-the-line Macs and 27” Thunderbolt displays. And of course, you need to give them stock options for the day when the privately-held company either goes public or is acquired. The irony of the company’s name is that many millennials probably wouldn’t know, unless it was pointed out to them by their baby boomer parents, that “cabbage” is slang for money. 

The financial services industry is experiencing a wave of innovation where several upstarts like Kabbage are taking an old product—money lending in some form has been around for more than two millennia—and using technology to create a 21st Century delivery and customer experience.The company provides small business lines of credit from $2,000 to $100,000, and more recently began offering consumer loans from $5,000 to $35,000, with repayment terms of either three or five years. Unlike most banks, which base their underwriting decisions primarily on the credit scores of the borrower, Kabbage takes a diverse range of information into consideration, and because the process is fully automated, the applicant receives an immediate decision. 

Although conventional wisdom would argue that Kabbage is a threat to traditional banks, particularly in the consumer lending space where much of its activity is focused on consolidation of credit card-related debt, Frohwein says that he wants to work with banks and would rather be seen as collaborator than a competitor. Kabbage’s principal offering is an unsecured business line of credit. Most banks won’t provide that kind of funding without some form of collateral, and they can take weeks to make a decision. Prior to this issue going to press, the company was expected to announce agreements to work with two international banks, and Frohwein was hopeful that similar conversations with U.S. banks would also bear fruit.

Like all fintech companies, Kabbage has benefited from growing consumer comfort with doing financial transactions online. According to Frohwein, 95 percent of Kabbage’s customers never interact with a human at any point in the process. And many of them seem to like it that way. Kabbage might be a company with a culture that has been influenced by the many millennials who work there, but it has created a product that is finding acceptance among borrowers of all generations, and that adds up to a lot of cabbage. Frohwein spoke recently with Bank Director Editor Jack Milligan

Let’s talk about why there is a Kabbage.

There is a Kabbage because you can actually access data from online sources on a real-time basis allowing you to do a couple of different things.

First, you can permit a customer to have a very elegant online experience.  The customer lands on the Kabbage website, which provides access to information relating to their entire business, and receives a decision within just a handful of minutes. 

Because Kabbage gains access to these data sources through the customer’s authorization, we have ongoing access to data. As a result, we understand how that small business operates, not just today—at the time of qualification—but how they’re operating today and any point in between. It gives us a very rich understanding of that small business.

When we started the company, we believed this information would better reflect how a business was going to perform as a customer rather than relying on the personal credit score of the small business owner. The whole premise of the company was based on data access and technology. Our DNA is technology and data access and how that access can provide us with unique insights and customers with better experiences. I think that’s probably what separates us from some of the other players that are in this space who continue to have a lot of manual processes residing within their customer experience even though most have adopted the “data and technology” marketing speak.

When the company formed, did you feel as though you were stepping in and filling a void that was out there for small business borrowers? In 2009, obviously, we were just coming out of the financial crisis. The banking industry had closed up like a clam in terms of lending, and there was a real credit crunch, especially for smaller companies.

For sure. Despite being responsible for most of the growth in our economy, small businesses have historically been treated as the redheaded stepchild of the financial services industry. They’ve been largely ignored over the years. Though we serve all small businesses now, when we started, we focused on online retailers. Traditional lenders are reluctant to provide an online retailer with a loan. It’s not that they’re not good customers, but they’re hard-to-reach and they often have limited operating histories. They don’t have a physical presence so you can’t walk into the store and hear the cash register ringing, and see the smiles on the customers’ faces. If you can serve that audience as Kabbage has, then you can serve all small businesses, because you start with the most challenging segment of businesses.

Explain the products that you provide.

We provide a working capital line credit for small businesses. In the fourth quarter of last year we also launched a personal loan product. We have both a small business direct product and a consumer direct product. 

We also started licensing our platform to third parties, which allows them to start lending in the small business and personal consumer lending space. We announced the first deal with Kikka Capital, out of Australia, a couple months ago. 

Have you also had conversations with domestic banks about the possibility of working with you under a licensing arrangement?

Yes. In the U.S., we are working currently with two banks. Those discussions are in a slightly earlier stage, but we believe we will execute agreements with both of them. One relationship will center on a small business product and the other is on the consumer side. 

The reaction from U.S. banks has been very positive, but it’s a difficult regulatory environment, and there’s a lot of caution that goes into that decision. It’s a process of working with the financial institution and getting them to the point where they really understand how we operate, how this compares favorably to their existing approach and how this grows their core business.

Do you see banks as competitors, or do you see them as potential partners? Or both?

I don’t think I see them as competitors, I actually see them as partners.  I try to help them recognize that this is a market they can serve, it’s not a market they should ignore, and there’s a legitimate partnership opportunity here. They don’t need to take a competitive stance with us. We think we can actually work with all the banks. 

How about in the consumer space?  Or do banks not really focus on the size of personal loans you provide? 

In the consumer space, our loans average about $15,000 and many of our customers are consolidating credit card debt so this is a segment in which banks are interested. Although banks may or may not see that as competitive, they should see what we are doing as important and core to them.  However, again, banks do not need to look at us as competitive.  We are working with a large U.S. bank right now to help them enter this space directly. 

Though very focused on the consumer lending space for many years, small business lending has been another story for them. It’s been traditionally difficult for banks to make profitable, and that’s because there’s typically high acquisition costs, and also there’s a lot of operational inefficiencies. Banks apply the same requirements and invest the same resources for a $30,000 loan as they do for a $3 million loan.  It’s just not reasonable to expect small business owners to go through that hassle for that amount of money.

Explain a little bit more about your underwriting process. It sounds like it’s a very sophisticated approach, and one that’s a little bit different than what most banks employ. 

When a bank underwrites a small business loan they will have a checklist of many items they need to collect: three years of financial statements, FICO score, an asset list, whatever it might be. A bank would expect every small business lending applicant to come to the table with the exact same set of documents and information. We take a different approach.

Kabbage must meet the small business owner where that small business owner is. That means if they have a specific set of relationships with accounting companies, or credit card transaction processing systems, or social networks, or shipping companies or whatever it might be, that’s the data we need to collect and decision on. The data helps us determine the capacity, character and consistency of small and medium-sized businesses, or SMBs, just as the items the bank collects attempt to determine.

We’ve had to figure out a way to basically say, “Give us access to any number of data sources.” Without getting too technical, it’s an API, or application programming interface, approach where we’re given automated access on these electronic accounts for specified information. We don’t have the ability to write to the account, so we can’t manipulate anything within it. It does give us the right to read the information that’s contained within the accounts. 

As you would imagine, it also provides us with a lot of historical information. It doesn’t just relate to the most recent period, it oftentimes goes back many months or many years in the past so we can see how these customers have performed over time. 

The real key to what we do is a couple of different things. One is we are able to take all that information and make it relatable. If somebody gives us access to their credit card transaction processing information and shipping information, and another person gives us access to their marketplace information, personal credit score and social data, we’ve got to figure out, “Okay, how do I make a decision on both of those customers, and make a decision that is consistent and fair across the board?” We have developed that capability over time, and we did that through a lot of trial and error, to be frank, where we made educated decisions as to how we were going to view information. Until you get repayment information back and see the customer’s actual behavior, you really don’t know how well correlated that information is to actual performance. We’ve gone through that process over the last several years. 

The nice thing about the way our product works is once somebody takes cash from our line, they pay it back within, on average, less than four months. Therefore, we are able to determine how effective our models are very rapidly. 

How do you find your customers?

SMB owners do not congregate in a single place. There’s not a hall where SMB owners meet each evening and you can advertise there. They’re everywhere the population is. Therefore, we have had to become experts at locating them.

We have a blended approach. We do both traditional and digital marketing. If you log on to Kabbage.com, we’ll probably follow you for a long time online, and you’ll see more ads from us in the future. On the traditional side, we do radio and direct mail. If you watch TV, you’ll be seeing ads in the fall. 

We also have a pretty robust business development arm where we enter into relationships with other businesses that have a lot of small business customers. It can be those that are offering phone systems to small businesses, or packaging for small businesses, or selling accounting software to them or whatever it might be. We try to work with the folks that work closely with small business owners.

When you look at the personal demographics of who your customers are, is there anything that’s distinctive from a generational perspective? What do you find interesting about your customer base?

We work with SMB owners that are super young and we work with folks who are much older.  However, they all embrace technology at least in some manner. Although we started with online retailers, over the last couple of years, we’ve grown to include all small businesses, so you get your restaurants, your dry cleaners and your professional service firms, and everybody in-between. We see a much broader demographic than we did in the past in terms of their technology savviness. 

You’d be amazed, 95 percent of our customers have a 100 percent fully automated experience. Not only do they not have to interact with anybody specifically at Kabbage, we don’t have a person on the backend specifically reviewing that file.  It’s all done through our system. You’d be amazed at how many of our customers are comfortable just interacting with our system. That didn’t happen overnight; we had to figure that out the hard way. We made a lot of mistakes, and we created some bad experiences, and we worked hard to make it as comprehensible as possible. That’s what we’ve really focused on over the last five years.  Now it seems easy, but we had many sleepless nights on the road to getting there.