Alternative Lenders vs. Banks

Alternative Lenders vs. Banks

In recent months there has been an influx of startups that offer alternative sources of financing. Marketed to small businesses and individuals, these alternative lenders exist largely online and promote a quick application process.

While these companies may provide access to funds for those who may otherwise face denial from banks, they typically offer different terms which clients may or may not find favorable. That’s largely the result of the conditions that led to the rise of alternative lenders in the first place, as well as the client profile of those they choose to target.

Why the Rise in Alternative Lenders?

Traditional banks operate under a more stringent regulatory environment as the result of the 2008 financial crisis. That means banks are more reluctant to approve mortgages or loans where there is high risk or low profit potential. Banks’ departure from this segment created an opening for upstart lenders that focus on niche consumers and businesses requiring funds.

How Do Alternative Lenders Work?

Alternative lenders finance those underserved by banks, leading some to assume they are taking on greater risk. However, some observers note they simply analyze risk using a different set of assumptions. While banks still have to support applications with substantial paperwork, alternative lenders can rely on sophisticated algorithms. Further, by focusing on niche segments, they can quickly establish volume and ensure returns.

Who Uses Alternative Lenders?

Small businesses are a major client base for alternative lenders. While 99 percent of U.S. companies are small businesses, only half of those with annual revenues between $100,000 and $1 million received the financing they requested from traditional banks in 2015. Underwriting these loans is expensive for banks, but an opportunity for alternative lenders.

Alternative lenders also focus on those with little to no credit history, or those with flaws in their credit reports.

Can Banks Compete?

Alternative lenders are distinguished by their use of technology to rapidly approve and manage loans. While there is the potential for traditional finance companies to enter into the space with similar platforms, advocates of alternative lenders emphasize ease-of-use is only one aspect of the borrowing experience, and new fintech companies may still hold an advantage.

However, because this space is still in its infancy, alternative lenders have struggled somewhat to get off the ground and to secure capital investment. Therefore, there may be room for banks to explore new lending options using similar models.

Are Small Business Clients Happy?

Perhaps the most telling piece of information when comparing alternative lenders and banks is client experience. Federal Reserve Bank of New York data published last year as the result of a 2016 survey demonstrated alternative lenders had some work to do in order to satisfy small business clients.

According to the survey, overall, small business borrowers were most satisfied with small banks (80 percent), credit unions (78 percent), and community development financial institutions (77 percent). That’s compared to 61 percent lender satisfaction with big banks and 46 percent for online lenders.

Among the reasons for dissatisfaction with online lenders were lack of transparency, high interest rates and unfavorable payment terms. Few applicants seemed to object to the application process, which is often marketed by alternative lenders as a key advantage.

Finding the Right Fit

Because there is a real need for various lending models, there’s little doubt alternative lenders will have a place in the financial market for the foreseeable future. For investors in financial markets and borrowers on the hunt for crucial financing, it’s largely a matter of weighing potential risks with benefits of engaging with this segment of the industry.

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