How community banks can keep lending local

Rising interest rates have created stiffer competition for loans. The Federal Reserve’s Open Market Committee has raised the Fed’s overnight rate at every meeting since March 2022 – during that time, that rate has climbed from just above zero to the current 4.5%, and more hikes are almost certainly coming.

To drive revenue, it is critical for community banks to prioritize expanding and diversifying their lending portfolios.

The lending landscape is especially crowded for small-dollar loans (full of competitors like Klarna and Affirm) and large commercial loans, but there is a notable need for more local, accessible and responsible financing options for medium-sized purchases. To fill this gap and create a new revenue stream, community banks should consider indirect lending for local businesses.

Most community banks would like to finance the customers of their borrowers, but the cost and resources needed to offer indirect lending make the idea of entering that field prohibitive. Instead, businesses often look to large banks or other fintechs. But with modern technology and the right strategy, community institutions can make this a lucrative and valuable offering to the community and the institution.

When bankers hear the term “indirect lending,” they typically think of the heavily saturated automobile market, but indirect lending is much broader. There is a huge market opportunity with community businesses where financing options are often needed – these include jewelers, heating and ventilation companies, orthodontic practices and funeral homes.

There are also markets that boomed during the pandemic and have been growing steadily since, like lawn and garden projects, home renovation and power sports. The investment in these areas isn’t expected to slow – for example, Stratview Research recently reported that the power sports market is estimated to grow 5.7% annually over the next five years to reach a value of $47.9 billion by 2027.

Lending locally can drive value for all involved parties. The end customer benefits by gaining an easy, convenient and quick way to access financing through a trusted, local institution, typically with a better rate. Local businesses benefit by gaining the ability to conveniently offer financing and provide quick answers to customers. The community bank benefits from this relationship because they are gaining new lending customers that could lead to a deeper relationship in the future, and they are creating a stickier relationship with their most profitable customers, commercial businesses.

For indirect lending to be profitable, community institutions must strategically leverage technology to simplify, digitize and automate the process. Customers should be able to apply for loans from their mobile devices with minimal documentation. If, for instance, a customer is at the jewelry store discussing financing for an engagement ring, they should be able to get on their phone and easily lock in a loan with a bank right then and there.

A strong indirect lending solution centers on automation. Once the borrower information is received, the bank should be able to deliver automated decisions based on their underwriting criteria. That way, loan officers would only have to manually review the exceptions. And automated workflows allow employees to manage multiple loans at once. This allows the bank to offer loans with more speed and efficiency, ultimately driving down the cost and resources needed to serve.

Digitally optimized indirect lending can also minimize the risk of fraud by ensuring there are adequate controls in place, streamlining documentation and performing a more comprehensive analysis on the loan performance.

Community banks have a substantial opportunity to bridge the current gap that exists for local financing options for medium-sized purchases. When done right, indirect lending can benefit the entire community and keep funds local.

Joe Ehrhardt is founder and CEO at Teslar Software