Readers of this blog know we often teach what we learn at our bank or at other banks throughout the U.S. However, this time we need more help. Specifically, for those banks that are trying to serve under banked or minority-owned commercial customer there is an inherit set of economics that are difficult to overcome. Very few banks in history have succeeded in this area and those who have did so prior to the 90’s. Given compliance costs and transactional friction, it is almost impossible to turn a profit. We write this article as a call for help hoping at least one smart banker or reader has the answer.
Here is the problem as we see it. The under banked or minority-owned business customer falls into one of three categories: 1) low income struggling business; 2) High to medium income, successful business; or, 3) High income very successful business.
For the low income business, the problem is that the transaction/compliance cost and credit risk usually outweighs the economics. Control on overdrafts, bulked up compliance departments, marketing and credit overhead expenses usually outweigh the risk-adjusted return on what is often a below average loan size. While technology will help here, the truth of the matter is that this area has and most likely will remain unprofitable. While banks will continue to conduct business in this area, save for a very few select banks that have found profitable niche markets, this will largely be the realm of limited, unprofitable community reinvestment act lending.
Then there is the moderately successful business that cash flows nicely, presents an average credit risk, but is still unbankable. In many cases, these businesses do not have complete financial records and when they do, they often do not match with IRS statements. While banks have been successful at education, getting many under banked businesses to pay their fair share of tax is difficult obstacle to overcome. This will change over time as the IRS will get better at policing these transactions through technology, but for the next five years, this area will remain largely the domain of 15% loans from hard money lenders.
The third category is the very successful minority business owner. This type of customer persona presents a paradox for many banks. While local community banks may get a small portion of this business, it has proven difficult to gain the bulk of the profitable business for several reasons.
One lesson we learned from recently talking with several successful minority business owners is the fact that while they would not mind helping out a minority-focused community bank, they feel more validated with the likes of a Citibank or JP Morgan. For a small subset of the American population, banking at these institutions (in particular) imparts a certain level of status in itself. More practically, these minority owners likely now have sizeable net worth and financial needs and have often outgrown the product suite of a community bank. Finally, there is the issue of marketing in that these individuals are on every institution’s radar screen so getting to these folks is often insurmountable for a community bank.
In addition to the above friction, to serve the under banked or minority owned business, a wide array of services is required. For example, while prepaid cards are popular, they are largely unprofitable for this customer segment and require the community bank to have a strong network of kiosks/ATMs plus the ability to handle foreign exchange to make the product line profitable. Many community banks are not prepared to handle all three of these elements.
We continue to try to seek ways to make the under banked and minority-owned business profitable as a customer niche. If any banker or reader has ideas, we would love to have that discussion as we need to learn from you on this one.
Submitted by Chris Nichols on June 30, 2014