How sound is this logic in today’s banking world? While the logic remains a hard rule for large companies, it is now really more of a guideline for small businesses.

Over time, a highly successful business will tend to outgrow its small local bank. Its need for credit, risk management, underwriting, treasury, foreign exchange and other financial services will eventually outstrip the human capital and financial capacity of its first bank. So larger firms pretty much have to bank with larger banks.

But small businesses have a choice. Not all large banks wish to compete for and retain small business accounts. And not all small businesses will embrace the small business banking strategies practiced by large banks. But when the right “small firm, large bank” match is found, your company can flourish.

The Increasing Competitiveness of Large Banks

Large banks traditionally eschewed the business of small firms. The risk-return proposition was unfavorable for (at least) two reasons. With large overhead structures, earning a profit on a small business account would have required large banks to charge uncompetitively high prices. And their centralized, headquarters-based organizational processes prevented large banks from collecting the local idiosyncratic information necessary to gauge the creditworthiness of small firms.

Several decades of advances in financial, information and communications technologies have changed the way that large banks do small business lending. Large banks screen and monitor their clients using hard information (credit scores, asset-based lending) rather than soft information (personal relationships, cash flows, character). Utilizing this high-volume approach to small business lending, large banks have cut their fixed costs of credit production while diversifying away credit risk. And the growth of secondary markets for asset-backed loans and
securities has increased the liquidity of these loans.

The bottom line: Should a large bank decide that it wants your business, it can offer you a broad range of financial services, plus plenty of room to grow, at prices that are highly competitive.

One Size Does Not Fit All

But the “large bank, small business” model can be relatively inflexible, and it will work only if your firm has the right characteristics. Because credit decisions are based on hard information and loans are asset-backed, your credit history must be strong, your financial statements audited, and your collateral relatively easy to value and sell. At a large bank, you may have a “relationship manager,” but your banking relationship will not be “high touch.”

So if your business didn’t come out of a cookie cutter, you will need the more specialized care that is traditionally delivered by a community bank. You will likely have to pay higher prices, but true relationships require investment on both sides of the deal: building a relationship is simply more expensive than being assigned a relationship manager. And at a community bank, you can be certain that the bank president will not get promoted away to a larger branch office.

A False Choice

If your firm is in the enviable position of being able to choose between a small bank and a large bank, then why choose? The best of both worlds would combine the personal attention of a community bank relationship with the broader offerings and growth potential of a large bank. Research studies in the United States and in Europe have found that small businesses with multiple banking relationships receive better prices and are less likely to have their credit rationed during economic downturns. Like two heads, two banks are better than one.