India 19 October 2016: During the Great Recession of 2008, lending from major banks fell precipitously, and the effect on small business owners was particularly pronounced. Even now, eight years after the crash, commercial loans of less than $1 million are still 20 percent under pre-recession levels, with nearly 80 percent of applicants receiving rejections. However, small business owners haven't been left high and dry - multiple advancements in small business lending, particularly in the fintech sphere, have emerged to fill lending gaps.
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As fintech and online lenders become a main staple in business lending, the industry is experiencing the following changes and advancements:
Traditionally, through centuries of banking, lending worked on a simple model. Banks accepted deposits from customers, and they lent a portion of those deposits to other customers. To turn a profit, the banks simply charged more interest to the borrowers than they rewarded to the savers.
1. New Lending Models
Fintech lenders don't accept deposits, so they have had to create new models to offer funding to their clients. For example, peer-to-peer lenders match private investors (who want to earn money through interest on small business loans) to prospective borrowers and, to earn a profit, the platforms charge a fee for arranging the connection. In other cases, fintech lenders use complex algorithms to quickly find underwriters for business loans, while other, larger companies secure loan repayments by pegging the loan to the business owner's account with the company and base repayment amounts and dates directly on incoming revenue.
2. Refined Credit ModelsIn addition to creating new lending models, new lenders have refined the picture of creditworthiness. In the past, high risk lenders often worked with consumers or business owners who had less than perfect credit, but they judged these borrowers on the same criteria as traditional banks and they simply mitigated risk by charging higher interest rates.
Fintech lenders have moved away from this type of high risk lending and have created new ways to assess creditworthiness and reduce risk. In particular, these lenders look at multiple data points related to earnings, revenues, reviews, online engagement, accounting records and countless other elements, and they assess a business owner's likeliness of repaying the loan based on that information.
3. Speedy ApprovalsIn most cases, the data collection process is incredibly fast. Loan applicants fill out online applications and share login information from various online accounts. Using a secure, token-based, encrypted process, the lender reviews the information in seconds and issues a decision immediately. Since most of the underwriting process is automated, the loan is funded within a business day of approval in many cases.
The speed of approvals helps to advance borrowing for most business owners. If they get in an emergency financial situation and need a boost in working capital immediately, they have a chance to access it quickly. In the past, this wasn't possible due to a lengthy loan review process and the funding times associated with traditional loans.
4. Varied Financial ProductsThe speed of funding is not the only thing drawing more and more business owners into the world of online lending - the varied financial products are compelling as well. Lenders still offer traditional, asset-secured installment loans for small business owners, but they also offer loans secured by inventory, unsecured lines of credit, factoring loans, equipment loans and a range of other small business financial products.
5. MicrofinancingWhile lending rates for small business bank loans under $1 million have not recovered from the effects of the Great Recession, the approval rates on loans worth over $1 million are even higher than they were before 2008. This fact highlights how hard it can be for business owners to get small loans, but outside of big banks, multiple organizations have again stepped in to fill this gap.
Microfinancing is becoming more popular both online and in the brick-and-mortar sphere. Many online lenders offer small business owners loans for as little as a few hundred dollars, and community organizations as well as lenders affiliated with the Small Business Administration are granting millions of dollars in microloans every year. Microloans are tailored to small businesses and are typically less than $50,000. In addition, they often include a mentorship or training component to make the funding even more effective than it would be on its own.
This shift in small business lending also takes into consideration multiple aspects of the business and the business owner. Instead of just looking at credit scores and business plans, for example, many microlenders focus on specific industries or give funding to business owners from traditionally marginalized groups. As a result, these loans span the divide between commercial lending and community development.
As fintech companies have stepped more prominently into the marketplace, so too has the issue of government regulation and oversight. Under current laws, fintech companies aren't necessarily subject to the same types of regulations and statutory requirements as traditional banks. This exempts these organizations from cumbersome bureaucracy, helping to streamline the process. But, to ensure they can continue to serve their clients without a lot of obstacles, the industry is preemptively embracing transparency in its practices.
6. Different Regulatory Considerations
While the final negotiations regarding government regulations aren't likely to happen for a while, preemptive collaboration from the industry combined with a political perception that small business owners need these loans bodes positively for future regulations. In fact, many analysts assume fintech lenders will ultimately face "bank-light" regulations that allow them to continue to lend money as they are at the moment. While behind the scenes, this new approach to regulation may affect customers more than other advancements as it contributes to interest rates, approvals, lending models and every other aspect of contemporary business lending.
Arguably advancements in business lending have changed the industry more in the last twenty years than over the previous few centuries. The advancements are diverse and affect everything from where borrowers get funding, to which types of loans they access, to how their credit histories are assessed and more. However, in spite of the diversity of the changes, they have a singular effect - more money is getting into the hands of the business owners looking to grow.