Small Business Lending and How the Banking System Missed Out

A small business owner in need of funding is no longer asking why the bank refuses them business funding. The question today, after a decade of exceptional growth in the alternative lending realm, is why turn to the bank in the first place. Banks are growing more and more irrelevant to the small business lending sphere. Some of the reasons for this inability to provide small loans are obvious and some are not as transparent. Yet, with more players entering the alternative lending market, with the technology capabilities rapidly increasing and people relying on the internet as a problem-solving entity, the banking world is facing a large- scale change. One that will only become more apparent in the years to come.

Any small business owner needing business funding knows the banks fail in three major aspects. First, the entire process is slow, full of paperwork, not to mention outdated, and a much-needed small loan can come too late. For a business that is not established, this time means money lost. Another problem that comes from turning to the bank is its focus on the owners’ credit score alone, which is set and the loan applicant has no control over. The third issue with asking for a loan from the bank is that most applicants will be turned away, for a variety of reasons. Many of those reasons have to do with the bank being tied down to a regulated, bureaucratic system, with write-offs, employee-bonuses or an urgency to generate greater fees. Banks are tied to harsh stipulations meaning they must act aggressively to prevent losses.

Recognizing the Problem

Some of the reasons for banks inability to provide small loans are less discussed and should be understood. In many ways, delving into the problematic structure of offering loans, shows two very important things. One, why the alternative lending sphere is only going to grow bigger. And second, if the banking system is to catch up to the financial revolution instigated by alternative lending, what these changes entail. It actually seems like the banking world is treating the alternative lending sphere like its surge is a huge surprise. As if alternative lenders are “stealing” loan clients. Banks have been around for centuries. How can it be that for such a huge market, and the small business lending market is indeed huge, the bank has become irrelevant? The alternative lenders are not to blame for this situation. The banks failed to treat these small business owners as clients in the first place.

One of the issues that most potential loan applicants need to understand is that banks are highly regulated systems that cannot offer different options to different clients. A small business loan can be as small as 40,000 dollars, but the bank loan product might be set at 75,000 thus necessitating the borrower take more than they need. Sometimes more than they can handle. Alternative lenders, free from scrupulous regulations can build the loan product around the small business. These lenders usually have diversified financial portfolio, with assets that do not lean as much on the up and down of the economic sphere. Essentially, this means they don’t add surprise sums to your small loan. They don’t need to balance themselves out as much as banks. For the borrower, alternative lending is much more straightforward. What you see is what you get.

Forgetting the Client

For many years the banks had the upper hand, in such an exaggerated way, that the small business owners seeking funding were not treated like clients at all. Some of these potential borrowers describe a system that treats you like a beggar, disappears for weeks leaving you waiting and some don’t even get a call explaining the loan won’t go through. The bank system took for granted that things were bound to change and that when there is a need, someone will fill that void. One of the greater failings of the banks was realizing the huge impact of technology. These outdated systems lacked the foresight to incorporate ML and AI into the credit appraisal process. This is an obvious advantage for alternative lenders.

AI and ML are the key elements of the banks failure to move to the 21st century. Today alternative lenders can assess a loan applicants credit worthiness based on many factors. Even social media use like a business page on Facebook and even Yelp can assess whether or not a small loan is right for a small business owner. Beyond these, technological advances can show an alternative lender who might soon be on the lookout for a loan. This way alternative lenders can advertise their product and reach potential clients before these clients have a chance to consider the bank. Offering unique funding opportunities at just the right time, is just another thing the bank is unable and unequipped to do.

Looking to the Future

Today the approval rate for small business loans by banks is at 30%. Using sophisticated algorithms alternative lenders cut the underwriting time from three months to three days. The biggest change created by alternative lenders is taking the “burden of proof” off of the small loan applicant and applying it to technology. The data is out there for those that know how and are willing to source it. If banks decide to team up with technological startups they stand a chance at getting in on the growing market. These days, information holding fintech compaoies have the upper hand with a 10-Billion-dollar growth in the alternative lending zone, in just five years.

If you want to understand how a company like Paypal has entered this field in such a dominating force, you must look at the work method. Analyzing potential loan clients’ needs before they even come looking for funding is the answer. This way, a client doesn’t need to come look for funding. It is offered at just the right time. This is the future of lending. The client is once again in the driver’s seat. No need to chase the bank. The right lender already had them in his sight. Without noticing, the times have changed and the lending market has left the banks behind. It will be very surprising if they will be able to catch up.