Alternative Lending and Fintechs Accelerate Small Business Growth in 2019

Eddie Davis , VP of Business Development at FINSYNC

19.08.2019 08:45 am

Fintech

alternative finance

The remarkable and rapid technological wave that has given rise to fintech and one of its biggest segments, online lending platforms, is showing no signs of slowing.

Fintech-powered financing is making business lending more affordable, more available and faster. The forces behind it are likely to gain momentum over the next couple of years as the industry continues to broaden its offerings, tap deeper into big data and mine partnerships with traditional banks that partner with fintechs to bring next generation services to their clients.

These trends bode well for businesses of all sizes, but particularly smaller companies and startups that have traditionally struggled to secure the financing they need to grow.

That's one reason alternative lenders fielded roughly 32% of all business loan applications last year, up from 24% in the previous year, according to data from the Federal Reserve. Moreover, the U.S. market for alternative business loans is expected to reach $350 billion by 2025, according to research from Balboa Capital.

That said, what are some of the key technology trends that will fuel further growth in alternative business lending over the next couple of years?

Fintech Partnerships

A trend that's been gaining momentum and shows no signs of slowing this year: Partnerships between fintech companies and traditional financial institutions.

The fintech sector has disrupted the financing industry, putting pressure on traditional firms to keep up with the faster and more user-friendly approach of online lending companies. Many forward-thinking banks and credit unions have opted to join with fintech innovators to stay competitive, without having to develop software internally. Such partnerships are good news for businesses, effectively broadening their access to capital.

Partnerships are also an increasingly necessary move for traditional lenders that want to grab a bigger share of the small business financing market. By teaming up with a fintech firm, they can improve their own internal underwriting, enabling increased speed without sacrificing risk analytics.

If partnering with a fintech for underwriting isn’t the best option, banks should also consider using fintech firms as a conduit to alternative lenders that already have the capability to underwrite loans to small businesses.

Fintechs can crunch large amounts of data drawn from small businesses that are using their integrated accounting and cash flow management services and quickly generate a more comprehensive and informed credit risk profile.

As a result, these partnerships can help traditional lenders clear some of the obstacles that they have faced when extending small business loans, including documentation, compliance, cost and underwriting.

The ultimate benefit for financial institutions: The scope of their lending business expands, strengthening their value proposition and consequently, enhancing acquisition and retention numbers.

Over time, the level of integration will become more seamless. Many alternative lenders are already backed by investment from traditional lenders. This trend will continue, increasingly blurring the lines between online lending companies and financial institutions that have been market participants for decades.

By the end of this year, about a quarter of retail banks will use fintechs to replace their online and mobile banking systems, according to a forecast by Gartner Inc.

Leveraging Big Data

The use of artificial intelligence to enhance decision making and reinvent business models is expected to grow, driving the payoff for digital initiatives through 2025 and beyond, predicts Gartner Inc.

Alternative lenders already reduce their credit risk by using A.I. to more efficiently analyze data and glean a more comprehensive and even predictive portrait of a borrower.

Online lending companies already differ from traditional lenders in certain ways that make it more likely for businesses to qualify for financing. For example, a traditional lender will weigh at least one or two years of a company's cash flow history, while alternative lenders may only need to look over as little as three months' worth of bank transactions. Alternative lenders may also look beyond a business owner's personal credit history when sizing up their creditworthiness and instead focus on the company's monthly revenue track record.

The higher degree of accuracy in credit risk management through the use of A.I. increases the chances that the lender can safely approve the loan, even if the borrower has less than stellar credit in a traditional sense.

An Essential Alternative

Perhaps the biggest reason that the prospects for growth in alternative business lending are strong is simply demand.

Alternative financing has been one of the key growth areas of fintech. Growth in alternative lending has served a wide range of industries with small businesses, in particular, being better served, given how much traditional bank financing for small firms has declined over the past decade.

Only three out of every four U.S. businesses with fewer than 500 workers got the financing they needed through loans, credit cards or other means, according to the National Small Business Association.

Alternative lenders still have some progress to make in order to boost their share of loans to small businesses. Large banks account for 48% of all small business loans, with about a quarter of small business loans being funded by online lenders.

According to the Federal Reserve's Small Business Credit Survey, online lenders have approved more small business loans than small and large banks for the past two years.

The future for fintech and alternative lending may be yet evolving, but now that early adoption has happened, more and more firms may look to technology-enabled firms, whether an alternative lender or a traditional lender with a strong partnership, to find the financing they need quickly.