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Banks: Big vs. Small -- Where Should Entrepreneurs Look When Shopping For A Lending Partner?

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Once upon a time, small-business executives had a clear banking choice: Pick a small institution for faster credit decisions, customized terms, and friendlier loan officers, or choose a large bank for a wider array of services, expertise, and convenient locations.

Now the choices arenít quite as clear, however; many of the differences between large and small banks are narrowing, according to industry experts. Large, regional institutions are improving personal service, cutting loan approval times, and beefing up small-business and minority programs, while small banks are broadening services such as payroll, insurance, and financial investing.

Still, executives in both banking segments insist that they maintain an edge in certain areas.

"I would challenge any community bank to provide the services and resources that we provide to small businesses," says Benito Almanza, head of SBA lending for Bank of America. "There are certain things we canít do, but 90 percent of the time we have the advantage."

If that were true, says Ignacio Urrabazo, president of Commerce Bank in Laredo, Texas, small banks would be headed for extinction.

"We are viable because people want our service," he observes. "We structure loans to accommodate the uniqueness of customers. We donít offer canned deals like large banks."

Following a wave of consolidation in the bank industry a few years ago, many industry analysts predicted that small players would not be able to compete with the growing depth of services offered by the giants. During the last 15 years, however, banks below the top 1,000 in assets posted the fastest growth rates for total assets and deposits, according to a recent study published in the Federal Reserve Bulletin. Small banks earned more on assets than their huge competitors. They also posted higher net interest margins Ė an important measure of profitability defined as the difference between rates paid on deposits and those collected on loans (see chart).

Net Interest Margin, Annualized: Large vs. Small Banks
Banking Chart
Interest margin is the difference between the interest rate a bank pays for deposits and the interest rate it charges for loans. Historically, small banks (defined as those with assets of less than $1 billion) have reported wider margins than large banks, meaning the small banks have borne more credit risk than banks with assets of more than $1 billion. But as the banking industry has grown more competitive, the difference has narrowed.


Small-bank executives cite several reasons for their competitiveness: They cater to markets that large banks have traditionally neglected or ignored, such as minorities, small businesses, rural communities, and inner cities; they provide faster decisions on loans and more flexible terms; and they dote on customers.

Many small-bank executives are willing to negotiate the terms of a loan guarantee or forgo it altogether. Nearly 25 percent of community banks either make non-guaranteed business loans or plan to do so, according to a recent survey by the American Bankers Association and ABA Banking Journal.

Many small banks also specialize in guaranteed loan programs of the Small Business Administration and the U.S. Export-Import Bank. Large banks offer the same programs. But overall, they tend to be less flexible about small-business loan guarantees, especially when it comes to startups and young firms, says John Guy, small-business segment director for Charlotte, North CarolinaĖbased Wachovia.

Small-bank executives also tend to make local, hands-on decisions, they say.

"Small banks personally evaluate loans in their local offices, not in distant locations Ö like big banks," says Allen Brown, CEO of Metro Bank, which has 11 branches in Houston and three in Dallas. "We make decisions faster, even on the same day," says Mr. Brown.

At Commerce Bank, which has four branches in Laredo, executives use their intimate knowledge of the area to offer credit to financially unsophisticated small businesses that larger institutions might reject, Mr. Urrabazo says.

He cites an example: "One customer plans to open a restaurant and wants to negotiate a deal without a realtor. Iím basically telling him how to do it. A large bank loan officer wouldnít take him by the hand like that."

New York National Bank, a Bronx-based institution with five branches, follows sound lending practices but gives small businesses reasonable benefit of the doubt.

"Very seldom does the [large] bank look at the financial statements from the point of view of the glass being half empty as opposed to half full," says spokesman Mike Gill.

Some large-bank executives actually admit that smaller players have an edge in personal service. Most think otherwise, however, saying the notion is a myth.

"Community banks, either factually or from a perception standpoint, have given people the idea that smaller is better, more intimate," says Mr. Guy. "Our local branches can give the same service."

Large banks depend heavily on the Internet to lure small businesses. They also have central loan processing facilities that receive and evaluate huge volumes of online applications using computerized credit scores to make fast decisions in a cost-effective manner, often within 24 hours. Credit-scored loans usually donít involve face-to-face meetings.

Chicago-based Bank One, for example, credit-scores loans up to $250,000. For the largest loans in that range, the bank also considers factors such as management and company history.

"We also take a second look at deals in urban environments and enterprise zones," says Vice-president Francisco Menchata.

Fast-growing Washington Mutual, the seventh-largest financial institution in the nation, is considering the use of credit-scoring for loans up to about $50,000. The trick, says senior vice-president Steve Pumphrey, is figuring out how to implement computerized loan approval while maintaining a personal touch.

"Weíre not going to back away from small-business customers, like money-center banks that ask them to do everything by an 800 number or on the Internet," he says.

Small banks pride themselves on personally reviewing every business loan application. Computerized evaluations are anathema to personal service and potentially hurtful to business, says New York National Bank spokesman Mr. Gill.

"Credit-scoring is fine if youíre a branch of a large bank getting 3,000 loan applications a week and you do very well by approving a few hundred of them," he says. "But small banks canít operate that way. It screens out too many businesses, especially in minority communities."

Executives at large financial institutions claim that big banks can do more for minority businesses because of their sheer size.

"We can offer all of the lending services that any company would need through its entire life cycle. How many small banks can do that?" says Wachoviaís Mr. Guy.

Wachovia, Bank of America, and Wells Fargo are among the nationís top SBA lenders. Some large banks set minority lending goals. For example, Wachovia recently announced plans to loan $5 billion to women-owned businesses through 2005. Wells Fargo set a goal two years ago to lend $3 billion to Hispanic-owned businesses by 2009. So far, the banking giant has loaned more than $1.5 billion, says Tim Rios, vice-president of the bankís Community Development Group.

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