Ask banking analysts about the competition for Wells Fargo's small-business loan program, and you hear a pause. After some shuffling of papers, there will be some hemming and hawing. Then a name or two may be offered tentatively. Perhaps a large regional bank is doing something somewhere.

In a business in which competitive edges are often measured in days or weeks, the Wells Fargo Business Banking Group appears to be years ahead of its competition in its ability to make substantial profits on corporate loans of less than $50,000. The reason: a clever idea developed in an innovative way, supported by intelligent use of information technology.

The implications of Wells Fargo's edge are startling. The bank went from $500 million in small-business loans in the late 1980s to $5.4 billion now. In the process, it went from being a small player in California to the highest-volume lender in the country in the small-business loan segment, with 300,000 loans outstanding. The loans have been so profitable that they helped first-half earnings at the Business Banking Group jump 45% from a year earlier to $128 million. These earnings accounted for a quarter of Wells Fargo's profits.

At a time when Wells Fargo has been suffering from indigestion following its acquisition of giant First Interstate, small-business lending has been an especially welcome success--and its role will keep growing. The technology involved has proved to be so useful that it is being applied to loans of as much as $3 million, meaning it could soon affect the vast majority of the lending done by Wells Fargo. Because of the reach provided by technology, Wells Fargo--which had concentrated on California in the 1980s and pulled back from national aspirations--now has a means to start expanding throughout the country.

While the banking industry seems to be focused on how big mergers and new entrants may transform the business, the Wells Fargo experience shows how good ideas that take advantage of technology can restructure the industry now.

The story begins with Terri Dial, who came to banking for the same reason many people choose a particular career: She needed a job. Having graduated from Northwestern University with a liberal arts education, Ms. Dial spent some time traveling the world, then decided to settle in California. To begin her job search, she picked up the Yellow Pages and let her fingers do the walking. Her fingers stopped at "B," for banking, and she became a teller at Wells Fargo in 1973.

She established early that she could take risks. By tradition, female employees were to take turns cleaning up the office, but Ms. Dial refused. She went head-to-head with the branch manager and won. She was soon managing branches herself, eventually running about a third of the Wells Fargo system.

In 1991, when Ms. Dial took charge of the Business Banking Group, which includes the small-business loan program, she had to face the almost religious belief among major banks that there was no way to make money on business loans of $5,000, or even $500,000. The top four banks in California were so wary of the market that their share totaled less than 10%.

The basic problem was processing. If a loan officer had to sit down with an applicant, then spend several hours reviewing his creditworthiness, salary alone would ensure that a small loan couldn't be profitable even if it were repaid on time.

To make things tougher, Ms. Dial was told her business had to be profitable on its own. Many big banks focused on their total relationship with borrowers, meaning that they were willing to lose money on small-business loans if they could also, say, sell profitable payroll services or hold deposits that paid little interest. But Wells Fargo management decided she had to be able to compete with nonbank lenders, who didn't collect deposits or sell other services that could subsidize losses.

In searching for efficiencies, Ms. Dial soon came to the key insight: that small businesses could be treated more like individuals than like small versions of big corporations. "Everything we do starts with that perspective," she said. "It's an entirely different relationship when you are banking the individual, who, in our opinion, really is the small business."

Wells Fargo decided to evaluate small-business loans almost like complicated versions of credit card applications, drawing on public records and outside databases to determine whether the applicant had had problems in the past. The question, of course, was whether a credit-card sort of scoring model would work.

Traditionally, big banks thought that small businesses were too dissimilar to be ranked by a scorecard. But Ms. Dial decided to trust in volume. Even if the model couldn't predict the risk on a single loan, she reasoned, it could predict the risk on a portfolio of loans.

"I was very skeptical. The bank was very skeptical," said Mike James, who worked for Ms. Dial at the time and whose background was in mid-corporate lending, which required lots of personal judgment. Mr. James said that "the most pleasant surprise was that you could model risk, that this could even be done."

The bank also took an unusual management approach. Rather than get everything buttoned down before rolling out the loan program, Wells Fargo decided to treat its early loans as research and development. It would accept losses if they helped it refine its model and portfolio approach.

"This is what we call the 'Aim, Fire, Aim, Fire' approach to product development," said Kevin Grieve, a partner in the Banking and Finance Group at

Diamond Technology Partners, the publisher of this magazine. "It can work very well, especially in uncertain marketplaces."

Once Wells Fargo had its model developed, the technology used to expand its rollout was relatively straightforward--and yet very powerful. At the core of the system are servers that are programmed to gather information on potential borrowers, whether from Wells Fargo's mainframes or from public sources. Those servers receive requests from laptops that are issued to the sales force, then relay reports back to the laptops. (The Internet only figures in the program in a minor way. People who have a banking relationship with Wells Fargo can apply for a loan on its Web site, but all others are steered to a lending officer. "I'm much better at going out and targeting who I want to lend money to than I am if I just let people walk in the door," Mr. James said, "and the Internet is a way of having people walk in the door.")

Relying on information technology not only kept costs down but greatly increased the speed of the transaction. Decisions on small-business loans used to take at least two weeks, often more. Now, someone applying for a loan in the morning could get approval in the early afternoon and even have the funds by the end of the day. In fact, if there's been a problem, it's that Wells Fargo can now be too fast. Potential borrowers often approach two or three banks, and Mr. James said they can sometimes feel that Wells Fargo hasn't been thorough enough, if its answer is back in hours while other banks say it will take weeks to review the application. So, salesmen sometimes wait a few days before saying that Wells Fargo has approved a loan.

The use of technology also allows Wells Fargo to manage its portfolio of loans more aggressively than in the past. It simply has its computers generate monthly reports showing which loans have become riskier and which less risky. Wells Fargo can then raise or lower the interest rates on the loans, to reflect the changes, or can take other actions to ensure that it gets paid. (Mr. James said Wells Fargo really does lower rates, because it wants to develop loyalty among customers.)

Wells Fargo had plenty of problems along the way. "We made some mistakes. Trust me," Mr. James said. For one thing, the bank found that it had to institute new sorts of operational controls to avoid new types of losses. It also took the bank a while to learn a crucial lesson--that not all loans should carry the same interest rate.

"In hindsight, that was pretty dumb," Mr. James said. "We'd have people with an 8% bad loan potential, and we'd have others with a 1%, and we'd lend to them at the same price." Wells Fargo has since adopted "risk-based pricing," which produces a huge range, from the prime rate plus 1 3/4 percentage points to prime plus 8 3/4 percentage points, Mr. James said. "Initially, it was unheard of for a bank to charge even prime plus four. This is just a different way of thinking."

Once Wells Fargo got the system in place, it rolled it out to all 50 states. "To be able to make loans in all 50 states without branches is a powerful thing," Mr. James said. "If we had to build" all those branches, "it would be a very different economic proposition."

Some analysts have said it's too early to tell just how successful the small-business lending program will be. In addition, the bank hasn't yet gone through a recession since starting the lending initiative, analysts said.

"You don't have a definitive reading on the [credit scoring] model until you get a market reversal," said Tom Stone, a vice president in the domestic bank group of Duff & Phelps Credit Rating. However, Mr. Stone also acknowledged that the Wells Fargo small-business loan program started its expansion during the California real estate downturn in the early 1990s, a difficult period.

David Fanger, an analyst at Moody's Investors Service, a debt-rating agency, is cautious about the impact of market changes. He thinks it is still a little early to declare the Wells Fargo program an unqualified success. "If competition heats up and you start losing some of your better quality customers, the loan portfolio quality declines and risks rise," Mr. Fanger said.

However, Mr. Fanger sees Wells Fargo's "virtual way" of marketing its small-business loans as something that others are trying to emulate. Wells Fargo itself "is no doubt thinking about handling other products in the same manner," he said. "Bricks and mortar are the most expensive part of any bank's operations."