Fintechs, community banks and the future of small-business finance

Dr. Miquel Velazquez doesn't have a lot of bandwidth to manage the flow of money in and out of his medical practice.

"I have a staff of one plus myself, so I can't put a lot on her plate in terms of figuring out our business needs," said Velazquez, a doctor in Westbrook, Maine, who provides muscular treatments out of a single office. "I have to handle whatever comes up that needs attention."

While Velazquez might seem like the prime target for a digital payments startup that promises a wide range of services through the web, he instead went with a local institution, Bangor Savings Bank, where he talks to a small-business expert about his practice's financial needs.

"I'm not looking for digital tech as much as I'm looking for responsiveness," Velazquez said.

It's not as easy for community banks to reach small-business owners like Velazquez as in the past. Large technology companies such as Square, Stripe and PayPal are gaining ground with small businesses by tying digital payments to financial products such as merchant credit. That trend threatens a major source of revenue for traditional financial institutions — community banks are responsible for 36% of small-business loans, according to the Federal Deposit Insurance Corporation, which reports that percentage has fallen from 42% in 2011. While still lagging community banks, fintech lending to small business has jumped from $121 million per quarter to $2 billion per quarter in the last seven years, according to the International Journal of Central Banking. Additionally, fintechs originated $6 billion in Paycheck Protection Program loans.

Community banks are fighting back, offering a mix of new digital offerings and traditional local expertise. To counter the fintech encroachment, Bangor has dispatched small-business specialists in its footprint to act as consultants and has introduced an incentive marketing program for local businesses.

Bangor Savings has about 100 employees in its commercial lending division, and it places 15 people in the field on a daily basis to meet with businesses. The $6.8 billion-asset bank has 65 branches and five business office and loan production buildings across New Hampshire, Massachusetts and Maine.

"A small business needs a good accountant, a good attorney and a good banker. You need to be one of those three partners to compete to keep small businesses," said Bob Montgomery-Rice, president and CEO of Bangor Savings, which covers Maine and parts of New Hampshire. "Even before you start your business, you need these people. As a bank, you want to be able to see and serve them in all phases of their business."

The bank just took a business banking program called "Buoy Local" out of beta testing.

The program is meant to encourage shopping at local businesses. Consumers use an app to fund Buoy Local purchases with any debit or credit card, then receive offers, track and redeem reward points. The app also helps consumers locate local sellers, which aren't necessarily the bank's customers, based on a particular product the consumer may want or based on a marketing incentive. The bank hopes Buoy Local will cement its position as a go-to lender for the many businesses operating in its footprint, with some early successes such as the bank's ability to connect with Velazquez.

The concept of the local banker personally connecting with mom-and-pop stores to battle well-funded competition seems rooted in a pre-internet era, but there are signs that small businesses still value hands-on experience.

Community banks can reduce the risk of disintermediation by offering access to some technology, such as digital payments, via partnerships with fintechs, while maintaining personal connections by demonstrating knowledge of the local community, according to the research from Fiserv.

These connections help the community bank understand the types of transactions and services that are required, making the community bank the enrolling institution. By enrolling business, the bank is better positioned to offer other services that may come from partners while maintaining control of the overall relationship.

Additionally, small businesses gave fintechs low marks for service for Paycheck Protection Program loans and other loans during the pandemic, potentially souring small businesses on using technology companies better known for payments as a source of credit.

Fintechs "can be convenient for some businesses. But in a lot of cases it's not the best solution for small business," and not all businesses are technology-forward, even as digital commerce advances, Montgomery-Rice said. That places the bank in position to help businesses respond to technology trends while maintaining an in-person touch. "Neighborhood businesses need more personalized help," he said.

The pandemic has created unforeseen challenges for small businesses, including compliance with health regulations such as vaccine card verification. While that's not directly related to banking, there's an opportunity for a community bank to act as an advisor, or to provide referrals, Montgomery-Rice said, adding that it can build a rapport that can pay off later.

One recent challenge for Velazquez was installing software to manage payroll digitally, a project that became burdensome as the doctor struggled to get help setting it up.

"Part of the confusion is I'm waiting to hear from someone who could install the payroll solution," said Velazquez, adding a rep from Bangor Savings who specializes in serving small businesses walked him through the installation.

Velazquez also needs someone who understands that his business doesn't have the background of a larger company that would attract a larger bank for a loan. "A small medical practice doesn't necessarily have the collateral, so the lender has to go with knowledge and expertise of the person who's running the business," Velazquez said.

Where there's a need

Small businesses have suffered during the pandemic, and their financial challenges will persist for months or years to come.

The Federal Reserve banks' 2021 Small Business Credit Survey reported 57% of small businesses report their financial condition as fair or poor. The report also found 65% of small businesses encountered challenges meeting operating expenses, and 43% have challenges paying rent, both of which create a need for short-term financing. The Fed found opportunity for small banks, noting 43% of small businesses turned to a small bank for credit in 2020, up from 36% in 2019.

But there is room for improvement. In general, bank lending to small businesses has mostly expanded slower than other sectors since the 2008 financial crisis, reports Florida Atlantic University, noting small-business lending in the past 13 years has expanded at about 2% per year, while business lending across all sectors grew at double the rate. 

Half of small businesses also report obtaining financing takes too long, according to the financial data company Plaid, which reports 86% of small businesses use their owner's personal credit record to gain financing.

Overall balances on small-business commercial and industrial loans declined by 13% in the second quarter of 2021 compared with the second quarter of 2020, according to the Federal Reserve Bank of Kansas City. The number of small-business C&I loans fell by more than 81% during the same span.

The Kansas City Fed's small-business study, released at the end of September, also found that credit quality and loan demand increased, yet bank approval rates fell as lending standards tightened.

Staying nimble

Larger banks are also targeting this market.

JPMorgan Chase, which serves more than 4 million small businesses, recently combined Chase Merchant Services with WePay, a fintech that JPMorgan acquired in 2017. The new line of business, called Chase Payment Solutions, combines payment acceptance services with digital tools that manage small businesses' other needs.

Like Bangor Savings, JPMorgan is trying to serve small businesses' needs beyond basic banking. In an October interview, Brad Brodigan, the managing director of global SMB for Chase Merchant Services and CEO of WePay, told American Banker that time is more important than money for small businesses.  

While JPMorgan has scale, there are benefits to being a smaller bank, according to John Tonjes, president of small-business lending at MVB Bank in Morgantown, West Virginia. The $3.8 billion-asset lender is relatively new to small-business banking but has gained early traction.

"Because we're small, we can customize. Everything is malleable," Tonjes said.

MVB, which has 13 branches covering West Virginia, Virginia and the Washington, D.C., area, formed a 14-person team to focus on small-business banking about two years ago. It originated about $80 million of loans in its first year and is on pace to pass $200 million in 2021.

The team specializes in health care lending, though it also serves restaurants and other small businesses and offers Small Business Administration loans.

Tonjes was recruited to build MVB's small-business banking program, and many members of his team have worked with him at other banks — often for up to 20 years. During that time, he said he and his team have developed skills to learn the borrower's personal story, more than just the financial need.

"The story is the most important part of the equation, whether they need a loan or assistance," Tonjes said. "You have to be in a position to know their story and have them be comfortable with you."

The bank recently integrated digital payments and merchant services with its lending portal. Credit applications are offered alongside point of sale hardware, for example.

"Part of what we do here is research what these changes in business or business needs are going to be and how that creates demand for new products," Tonjes said.

For example, Tonjes's team noticed an increase in demand for home health care services as people looked to avoid assisted-living facilities during the pandemic. That has led to a jump in small business launches to provide at-home assistance, and an opportunity to offer financial services and technology to a new category of business clients.

"We focus on stuff like document automation, making processing easier," Tonjes said. The bank adds merchant services technology in line with its research to ensure it's not falling behind the speed that fintechs offer, he added. "We want to be careful with that. We want people to know we're not just using digital onboarding for credit scoring."

To spot the needs a larger technology firm may miss, MVB assigns relationship managers to its small-business clients.

The challenges that crop up for businesses may not be directly related to banking, but often require a financial solution. Many of the bank's clients are small enough to have one one or two employees. If one of those employees handles the business' books, that could result in that business missing payments or having other liquidity issues. Often, a very small business doesn't know who to contact with that problem, Tonjes said.

"At a larger financial services or fintech company that merchant's story may never get heard," Tonjes said.

Community banks can also compete for small-business banking while ceding payment technology to fintechs.

Atreyu Running Co., for example, uses Shopify and Square to support e-commerce and digital payments, but does its primary banking with Keystone Bank, a $480 million-asset bank, which like Atreyu is based in Austin, Texas.

"In comparison to the big players in the industry, we're quite small, but we're big enough to provide jobs to five employees in Austin," said Michael Krajicek, founder of Atreyu. "Keystone's a tight-knit group of people who have always been interested in the Atreyu journey."

Krajicek founded the company during the pandemic. It had to ramp up quickly to accommodate people who wanted shoes to jog but could not go to an athletic apparel store in person.

"At any point in time I can pick up the phone, ask questions and talk to Keystone," Krajicek said.

That's been helpful in learning about the different financial services that are available for startups, Krajicek said. The company has a credit line to manage sudden changes in inventory in anticipation of a spike in demand.

"I sometimes think to myself, what is the proper way to leverage this line of credit or loan," Krajicek said. "How can we make the most of this relationship with the bank and what is the higher possibility of fueling growth for my company?"

The fintech threat

Many large fintechs — including PayPal, Square and Stripe — offer capital to merchants, a practice that has attracted more investment during the pandemic as businesses suffered liquidity problems.

Square Capital, which uses a small-business client's past payment flows to inform lending decisions, has grown quickly. Quarterly volume jumped from around $100 million in the first quarter of 2015 to around $900 million in the first quarter of 2021, according to Statista.

Clearco, another digital lender that focuses on small businesses, projects it will end up lending $1.5 billion during 2021, which would nearly triple its 2019 total, according to Quartz. PayPal, which has offered working capital to merchants for about eight years, is combining lending and payment services into a single "super app" that poses a competitive threat to banks in business and consumer lines. And Stripe's large valuation and popularity with investors gives it flexibility to acquire other fintechs to expand its services, which primarily are designed for small businesses.

Stripe, for example, has a startup toolkit service that helps small merchants navigate the legal issues required in setting up a business.

Where a firm like Stripe can compete is in providing speed and ease of deployment, according to Yunong Xiao, head of engineering for online databases at Stripe, which recently expanded four of its products — Stripe Tax, pre-authorized debits, faster payouts and a new reader for Stripe Terminal — to Canada.

Stripe also recently agreed to acquire Bangalore-based Recko to automate payment reconciliation for small businesses, part of a series of investments Stripe has made over the past year to build a suite of back-office services for businesses as an alternative to banks. It also became a preferred partner of the Swedish installment lender Klarna.

"Getting set up for payments is a pain point for businesses," and the ability to access different types of businesses from a centralized location quickly is the key to responding to an unexpected crisis or challenge, Xiao said. "We provide a means for business to get set up without having to write code and bridge online and offline environments."

PayPal offers a concierge service for small businesses that includes checkout, cash-flow management and invoicing, creating an enrollment venue that can later feed PayPal's lending service. Square has a range of services that include appointment booking, inventory management and marketing that it can pair with its more traditional payments services.

"These fintechs have stepped up and provide more insight than banks have," said Ian Benton, a senior analyst at Javelin Strategy & Research. "That's why the fintechs have made gains."

The differentiator between community banks and fintechs is the banks can put a face behind the technology to help answer questions such as these, Keystone CEO Jeff Wilkinson said.

"There's unbelievable payments technology out there in the fintech space. We recognize that," said Wilkinson, who founded the bank in 2018. "But it's wonderful until it's not."

While Keystone has partnered with technology companies to offer digital banking and payments to the tech-savvy Austin market, Wilkinson contends that banks' expertise in regulation and compliance better positions them to work with merchants.

Even for a new bank, a legacy of banking as a heavily regulated industry creates an expectation of personal service or guidance, according to Wilkinson.

"People have been writing off community banks for years," Wilkinson said. "But the more fintechs that are out there, the more there will need to be community banks for when things go bump in the night."