A World of Unknowns: An Automated Approach to Small Business Lending
I hope everyone had a fabulous holiday season!
With 2021 before us, everyone wonders what to expect. Or, to say it differently, “now what?!” I prefer a more positive note - what can we add or recalibrate to gain efficiency and provide a strong client experience without adding risk?
If your community bank or credit union is using auto decisioning today for small business lending, you may wonder if you should continue. Or, if auto decisioning is something your financial institution (FI) is considering, you may wonder if now is the time to launch this loan program.
There is no right or wrong answer. What is important is to understand your FI’s risk tolerance and willingness to do additional reporting and monitoring of the auto decisioned portfolio. Some things to consider:
- Auto decisioning a small business loan should never be just score. It should always include score plus other factors that the bank or credit union deems important as part of the decision process.
- These factors (plus the score) may include information that leads to an auto approval, auto decline, or requires a manual review. These should be based on the FI’s policy and procedures and risk tolerance.
- Some factors to consider include NAICS, time in business, deposit amount, region, etc. These factors should reflect the FI’s concerns and will vary by institution. Do not forget the factors we always consider like previous bankruptcy (business and personal).
- Focus on more than just the NAICS like restaurant and hotel. What other industries are also affected? What regions are harder hit?
- Consider limiting the products and dollar threshold for auto decisioning (dollar threshold should be based on total exposure, not loan request.) Based on economic conditions, at what level is the FI comfortable with no financial information?
- For those FI’s already utilizing auto decisioning, the level may have been $100,000 in 2019. It may need to move down to $50,000 for the foreseeable future.
- If your FI is deciding to move into auto decisioning in 2021, consider low dollar thresholds and one or two products to begin. This will help limit risk and allow the FI to “test” the process.
- Monitoring of auto approved loans is crucial. Robust portfolio management, rescores, and reporting are all necessary.
- For reporting, it is important to continuously compare the delinquency percentage of auto decisioned loans to those judgmentally underwritten. The delinquency percentage for auto decision will be higher, but it should not be appreciably so. If it is, it is important to analyze your data and make appropriate changes to the score cutoffs and other lending factors.
- I always recommend that proactive portfolio management be in place prior to auto decision. Behavioral analysis is key when financial information is not part of underwriting.
This blog only scratches the surface of this conversation. There are many things to consider. Auto decisioning is still an option, but it needs to be managed appropriately.
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Posted on Friday, January 8, 2021 at 8:15 AM
by Stephanie Butler
As Director of Advisory Services, Stephanie Butler guides the implementation and strategic consulting for new and existing Baker Hill clients. Butler coordinates the Business Process Consultant team and is responsible for analyzing client goals and objectives and providing recommendations for best practices. Relying on more than 25 years of experience within the financial services industry, she successfully maintains a client base of banks and credit unions ranging from $100 million to $100 billion in asset size.
Butler earned her bachelor’s degree in Accounting from Davenport University and received her master’s degree in Management from Aquinas College.