Over the last 30 years no event has had a greater effect on the lending world than the 2008 recession. The economic crisis had such monumental consequences, that the lingering aftershocks are still felt to this day in the financial field. The ramifications swept through every economic sphere, from housing to business establishments to personal credit. The enormity of this crisis raised two questions. One, how was this happenstance not predicted by the financial field’s professionals? And two, does the 2008 recession still have an effect on the lending world today?
As a result of this crisis many prospective borrowers suffered a major blow to their credit worthiness. In simple terms, the crisis occurred due to borrowers’ inability to return loans. The fact that this became such a momentous catastrophe shows the fragility of the lending system as well as the entire economic sphere. The housing market lost its value in an unprecedented way. Specifically, these unpaid mortgage loans started a ripple effect in the entire American economic world leading to homelessness, unemployment and even forcing taxpayers to bail out the stock market, in an attempt to lessen the shock to the American economy. It is no surprise the concept of lending completely changed for traditional lenders.
What Business Lenders Know
Ultimately, the concept of alternative lenders emerged from this havoc. As banks no longer wanted to take the risk on those without credit worthiness, a new market came to be in order to fill the vacuum. Though small and medium sized businesses no longer held much appeal for banks in terms of lending, they still needed funding. A business without funding lacks the means to grow. Alternative lenders suddenly had a vast population in dire need of accessing loans. On the one hand, potentially millions were available as clients. On the other hand, these were loan customers with bad credit, and possibly very risky for lenders. The question being were alternative lenders able avoid the potholes of bad credit in offering business loans if banks cannot?
The issue isn’t new but has always been at the base of the lending sphere. Borrowers and lenders have a unique relationship with cumbersome setbacks from the start. How can a lender have a complete and true overview of their borrower? Beyond the problem of credit, a lender does not have the ability to accurately determine a borrower’s business competence and acumen. The potential lender has no access to what business opportunities their clients have, their management skill or how much effort they put into their work. Nor does a lender understand the work relations and even personal conduct of the borrower. It is for these reasons credit scores became such an important factor when assessing loan recipients for banks. It is supposedly the only method of estimating how a borrower handles their finances. By creating a grading system, a lender has a clear view of who they are lending to.
Overcoming Tradition by Innovation
Yet, credit analysis cannot be the only factor in risk management. There are other ways of deciding a loan client’s competence. Of course, lending with very high interest rates is a way for lenders to offer loans to those without credit. The problem nowadays, as the economy is booming and thriving again, borrowers are slowly moving back towards traditional lending. No one wants to pay higher interest rates, if they can avoid it. In 2018 many people saw a positive change in their credit worthiness and looked to the bank for business loans. In fact, according to Experian’s Clarity Services, an agency offering data to financial lenders, 7% of overall 2017 borrowers migrated to traditional lending in 2018.
This means that while alternative lenders were the promise of the lending world, following its 2008 crisis, the concept is still considered suspicious and vague in many potential clients’ view. Some of the reasons proposed for the transition back to traditional lending have nothing to do with alternative lending’s high interest rates. First, as technology advances, so does online fraud. Borrowers feel banks are a safer route, when their finances and savings are on the line. Second, studies show older generations, including the Boomer generation and even Generation X, basically those born before the 80’s, are more inclined towards traditional funding. And finally, 2018-2019 have seen an economic boost, which has raised incomes and therefore credit worthiness of loan seekers.
What the Future Holds
Banks have been the only source of financing for so many years, it is no wonder fintech and alternative lending seem unsteady to some. All new concepts need a period of adjustment. The financial world is traditional and highly regulated because it is unsteady and fragile. Arguably, two good thing have come out of the recession a decade ago, in finances. First, a reevaluation of the lender-borrower relationship and how to evaluate a loan recipient. And second, finally banks have alternatives, a concept that is as critical today as it was when crisis hit the economy.
Alternative lenders have many advantages over banks, including less paperwork, a less regulated system and a much simpler approach. As predicting the economic future is futile, the focus should be on learning from the past. Luckily, these days, there are plenty of technological advancements that offer a much clearer picture of potential borrowers. The more data a lender has, the clearer picture of who the borrower is. All this leads to a potentially accurate loan structure, based on the capacities of the loan recipient, without the restrictions of a bank loan. Alternative lenders have the potential of beating the banks at their own game. It is merely a matter of opening up to the opportunities offered by technology.