Demand for business loans continues to rise, especially when it comes to SME borrowers. On the other hand traditional funders like banks and credit unions continue to decline the majority of these applications. And they use a slow, paper-based process to come to their negative conclusion. This is good news for alternative lenders who can leverage technology to approve far more loans with a faster, easier process that supports better credit decisions.
In this article we’ll review four reasons why we believe SME lending is an untapped area of opportunity for alternative lenders. First, demand is high. Second, traditional lenders decline three out of four business loans. Third, credit unions are handcuffed by lending caps. And fourth, institutional investors are pumping liquid assets into non-traditional lenders.
We’ll also identify two obstacles alternative lenders must overcome to achieve success.
The competition for SME borrowers is heating up. Right now is a great time to position your brand as a “go to” resource with this lucrative community.
SMEs seek funding to support growth
Demand for business loans is at an all time high, and for all the right reasons. 44% of the small businesses and 47% of the mid-size companies who apply for a loan are in a growth mode. They’re looking for additional funds for one of two reasons. They’re scaling their business with new clients and larger orders. Or they’re acquiring a smaller specialized company in order to expand their capabilities, without having to build those capabilities from scratch.
Conclusion: SMEs will to turn to alternative lenders when they risk losing out on growth opportunities if they have to rely on a bank.
Traditional lenders stuck in outdated legacy systems
Big banks and traditional lenders decline business loan applications at an astonishing rate. Only 26% of small businesses were approved in the first half of 2018, according to the Biz2Credit Small Business Lending Index. Compare that percentage to alternative lenders who approved 56% of their business loan applications. That’s more than double. It’s no wonder the alternative lending category has grown by 22% YOY in the US and 43% YOY in the UK for the past six years.
SMEs used to start with traditional lenders, hoping to get a lower interest rate and longer payback term. Then after their application was denied they’d turn to an alternative funding source. Unfortunately, this first step could take 30-60 days to complete.
More and more SME borrowers are bypassing traditional lenders to save time and frustration. Alternative lenders offer a streamlined application process, and their rates are becoming competitive with banks. This happens when they pass along savings derived from lower operating costs and lower chargeoffs achieved from fintech systems.
A handful of big banks are launching online lending platforms. For example, Marcus by Goldman Sachs. However, only 30% of banks actually deliver a fully digital experience and only 6% deliver a fully mobile experience. Less than 20% of banks offer instant credit decisions. And 70% still require borrowers to come into a branch to provide ID verification, original documents and live signatures. These banks are stuck in an outdated mindset. They’re doing little more than creating a digital version of legacy processes. Alternative lenders on the other hand start with a customer-centric mindset. They develop a platform that delivers a fast, easy borrower experience.
Conclusion: SMEs will turn to alternative lenders as long as big banks decline 3 loans for every 1 loan they approve. And use an inefficient, time consuming application process.
Credit Unions handcuffed by lending caps
Credit Unions approve 40% of business loan applications until they hit their member lending cap which restricts business loans to 12.25% of their total assets. Most community banks would like to extend more business credit. After all it’s part of their mission to support local businesses. And many have the surplus capital. The NAFCU (National Association of Federally-Insured Credit Unions) is working to raise the cap to 27.5% of total assets, so they can pump more business capital into the local economy, but so far the lending cap hasn’t budged.
Another major obstacle for credit unions is technology. They’ve been notoriously slow to adapt fintech platforms that would improve the borrower experience, reduce operational costs, and improve credit decisions.
Conclusion: SMEs will turn to alternative lenders as long as their local credit union is restricted by lending caps and paper-based application processing systems.
Insurance and pension funds get in on non-traditional lending
Institutional investors like pension funds, family funds, insurance companies and other non-bank lenders are all looking for new places to invest their money. Over the past few years they’ve become more active in business lending, due to the combination of strong demand and solid returns. Some of these groups are offering low interest rates compared to banks, by leveraging cutting edge technology that increases efficiencies and lowers operating costs. Plus they’re using sophisticated data analytics to improve credit decisions and maintain low default rates, even when evaluating companies with marginal credit.
Conclusion: Alternative lenders can partner with institutional investors by sharing their technology platform in exchange for marketing access to the customer base.
Two obstacles when targeting SMEs
There are two obstacles alternative lenders will need to overcome to be successful with SMEs: specialized lending technology and decision software, plus increased regulatory scrutiny.
Alternative lenders absolutely must be fintech-enabled to provide a fully digital application and funding process with instant credit decisions on desktop and mobile devices. This type of automation delivers an exceptional user experience for the borrower, plus processing efficiencies and profitable credit decisions for the lender.
In addition compliance rules are changing as the industry gains visibility. The regulatory agencies are publishing new rules at an accelerated pace. Plus they’re launching new cyber units, specifically created to oversee programs that use digital channels.
LaaS platforms deliver cutting edge technology plus regulatory compliance
It can be challenging to approve the right accounts with the right pricing in real time. Traditional banks who try to get by using a digital version of their legacy processes are missing the mark with today’s borrowers. That’s why top funders use cutting edge technology with specialized lending software to solve a myriad of origination and account management challenges.
There are a number of good LaaS platforms who provide fintech software systems to alternative lenders. These platforms provide automation and advanced credit scoring that minimizes processing time without compromising risk tolerance, accuracy or security. Regardless of whether the system is reviewing a new application, managing payments, or using predictive bad debt triggers to monitor client credit scores.
Look for a cloud-based system that’s fully managed, easy to deploy, and easy for your team to master. It should be a rules-based system that can be customized to meet individual requirements, and it should be regulatory compliant out-of-the-box. The software upgrades should be automatic at a platform level with no additional programming on your part, including compliance updates as soon as they are published. The platform should include a proprietary scoring model that uses machine learning and ongoing analysis to constantly fine tune the score card. And it should include alternative scoring models that can evaluate prospective businesses with little or no information at traditional credit agencies.
Look for an enterprise developer that’s forward thinking in order to stay ahead of tomorrow’s business borrower. We believe they’ll want instant gratification just like today’s consumer borrower. The platform should already offer multi-channel availability, where applicants can start and save an application on one device and seamlessly re-start and complete the application on another device. And the platform should be working toward an application-free experience, where approved customers enjoy instant access to additional funds every time they open their mobile banking application.