Why Commercial Credit?
Commercial Credit, Small Business Credit, Digital Lending
Its Critical Link to Wealth Creation throughout History, and How Banks Can Ensure That Main Street Reaps Its Rewards
For 3,000 years, the process of making a loan to a small business has remained largely unchanged. However, we’re at a transition point in history in which technology can help this millennia-old process evolve. Tech innovations – including automatic information collection, faster borrower analysis, and access to large amounts of data to determine underlying risk – can turn this costly, outdated process into a profitable, seamless experience for lenders and borrowers alike. The digital transformation of lending will help small businesses and the economy thrive.
At PayNet’s recent Executive Banking Forum, former U.S. SBA Administrator and Harvard Business School Senior Fellow Karen Mills delivered insights into the history of credit. She highlighted how outdated and costly the system of making a loan to a small business is and offered recommendations for modernizing the process. Her discussion led me to do my own research on the history of credit. What I found is that credit has been linked tightly to wealth creation throughout the ages, and banks today are in a rare, exciting position to lead the charge on fixing a 3,000-year old problem of getting credit easily, seamlessly and profitably into the hands of small businesses.
The Wellspring of Economic Life
In A History of Credit & Power, authors Scott B. MacDonald and Albert L. Gastmann discuss how credit serves as a wellspring of economic life, enabling businesses to function.
Moreover, where there is credit, there is power, with credit creating wealth and augmenting power. Where trade, entrepreneurship and commerce occur, credit is needed. And, if the political environment is geared toward property ownership, then credit and ensuing economic growth are evident.
The history of credit is full of volatility and innovation, with banking houses coming and going and credit cycles booming and busting. However, the general trend has been towards innovation. The democratization of credit is the next major trend as credit has transformed from a system for big government and big business to one for consumers (e.g., mortgages, credit cards, auto loans). By embracing digital technology, we can ensure that small businesses aren’t left out of this next phase in credit’s evolution.
A Brief Historical Overview
During the Pre-Modern period through the reign of the Roman Empire (1726 B.C. – 400 A.D.), coinage did not exist, so trading was done in goods at large-scale public facilities (usually temples), which served as central locations for storing goods, transacting and clearing.
By contrast, invasions and war in the Late Pre-Modern period (400 –1090 A.D.) led to a subsistence living, so credit systems completely disappeared.
The Early Modern period (1090 – 1500 A.D.) included a series of innovators from the Knights Templar—who kept the roads safe and gravitated towards money transactions—to the Medici family in Italy—who dominated commerce in banking in the 1400s.
In the Modern era (1500 – 1990 A.D.), the Bank of England’s (BoE) founding in 1694 represented a major step forward by providing a credit system to move the industrial revolution along; meanwhile, credit in the U.S. had a modest start spurred by a need for credit during wars.
Finally, while today’s global credit systems have made the benefits of credit available to hundreds of millions of people, contagion remains the bane of credit as a run on available capital can spread quickly and result in credit drying up.
Leading the Charge on the Next Phase: The Democratization of Credit
Credit derives from the Latin “credere,” meaning “to trust.” It works because of the trust and confidence among parties involved in the transaction. Credit creates wealth, and prudent use of it is required. When loss is greater than repayment, the system can quickly collapse.
When you look back at the first credit process in 1300 B.C., you see that things haven’t changed much since then. The time it takes for a small business to secure a loan is longer (45-120 days) and making a loan to a small business can cost upwards of $15,000 per transaction. As a result, loans of less than $1mm to small, local merchants are down 33% since 2008, the same period during which GDP rose 23%.
This doesn’t make sense.
We’re at a historical turning point in which banks have access to new technologies that can be leveraged to safely make credit available to more borrowers than ever before. Digital lending innovations can ensure that no one is left out of this opportunity to secure capital, including small businesses.
If we have learned anything from history, it is that small businesses must have access to much-needed capital to ensure growth and success. And, banks are uniquely positioned to democratize credit by using technology and information to make that much-needed capital accessible to every creditworthy private company. With digital lending portals, they first can process possible borrowers quickly and assess whether to pursue them. Then, they can pull in a credit decision engine to gather and analyze the applicable borrower data. Third, they can apply the credit policy and process, enabling an automated review along with compliance checks, terms and conditions and credit structure. Finally, they can deploy technology which significantly reduces the cost of underwriting and reduces the process from months to a few days or a week.
As we move toward the democratization of credit, banks are in the prime position to close the small business credit gap once and for all. Are you ready? Learn more.