By: Matt Ward-Steinman, VP of Solutions Development
The process of underwriting and boarding merchants (the diligence process) continues to evolve, having already taken great strides over the last two decades. Whether your business provides commercial loans, payment acceptance (i.e. credit cards or ACH), or other business services to merchants, many of the same principles apply when it comes to diligence.
Speed, automation and efficiency
Over the last twenty years, with the cost of computing greatly reduced and the advent of the internet, many diligence processes that were previously manual or paper based in nature became real-time and electronic. For example, pulling a credit report is almost entirely electronic today in the U.S. Yet, with all these advances, many institutions still spend over $200 and more than 5 days to underwrite a small business.
Cost Effective Information
With perfect information, one could accurately assess the risk a merchant poses to future continuity and profitability. Even if perfect information were available, it would be cost prohibitive. So the key here is balancing the costs with the quality of information, omitting those sources that are too expensive and those that provide minimal predictive value.
Two approaches commonly used to reduce up front diligence costs
- Least cost decisioning: This is the concept that early, less expensive tests in the diligence process can eliminate the necessity of costly further steps. An early process step like puling a credit score, or a G2 Compass ScoreTM, can eliminate high-risk merchant applications early in the process, avoiding costly additional steps. Similarly, given a very favorable score, some further diligence steps may be skipped (e.g., pulling the full credit report for a credit score of 800).
- Continuous Underwriting: This concept really took root with the advent of businesses serving the micro-merchant population, the very smallest merchants that typically don’t have a direct business banking relationship. Here minimal diligence is undertaken initially. As the merchant matriculates and grows in revenue, payment transactions, working capital, and commercial lending needs, additional diligence steps are taken.
There’s a danger in over-tightening the risk controls
Similar to the credit polices a merchant employs to extend payment terms to its customers, Financial Institutions, (FI’s) apply a similar mechanism with underwriting. In the merchant credit policy example, business tomes are replete with examples that explain how zero bad debt from customers really translates to lost sales. A corollary to this applies to underwriting but with an added wrinkle. If a merchant never defaults, then the diligence process is too tight equating to lost sales. The wrinkle is that financial institutions don’t live in a binary world of accept or reject; they can accept with means to mitigate risk. Raising the interest rate on a loan, or the discount rate applied to payment acceptance are obvious examples.
The G2 Compass Score
The recent launch of G2 Compass Score is an exciting development for financial institutions that employ small business diligence and underwriting. It addresses all the trends and needs described above, while leveraging the expertise and proprietary data G2 has developed over the last decade. It is available via an API and is very easy to integrate into existing systems and third party software applications.