Published on November 30th, 2020 | by Sunit Nandi0
The engine behind better decision making for online lenders
With businesses more in need of credit since the 2008 crisis, online lenders are there to fill the gaping void that banks are failing to address. Across all major economies, banks are averse to small business loans, with lengthy application processes and ruthless credit checks.
Tech driven business loan companies, however, have been a huge success during the Coronavirus period. Whilst they have been growing in popularity for a number of years now, the influx of small businesses seeking loans has grown recently.
So, how are these online lenders outperforming banks, and why can’t banks keep up?
The differences in service between online lenders and banks
Before looking at the infrastructure differences and innovation behind online lenders, lets first lay out the differences in service. Banks are the place to go when businesses want million-dollar loans that span 10 years, and have very low cost. Banks, of course, still very much provide these loans, and will ask for significant collateral and high credit scores in return.
Whilst banks take several weeks, or even up to 3 months, to process business loan applications, online lenders take a matter of hours. Speed isn’t the only difference, but your chances of approval are drastically higher with an online lender.
As a result, interest rates are higher with online lenders, but given that repayment plans only span a few months to a few years, this can often be manageable.
The technological advantages of online lenders
Online business loan companies have much faster application processes because of three reasons: innovation, a different approach to risk, and regulation. As ever, fintech companies are the driving forces behind technological advancements.
We have seen fintechs come to dominate retail investment brokers, online banks, remittance, and so lending is no different. And if any of these industries aren’t yet fintech-dominated in regards to market share, they are the ones progressing features, service and competitiveness.
Online lenders are utilising machine learning algorithms to help predict and assess the risk of borrowers. This means that they ask for instant, tangible data, such as the last 2 years of profit and loss numbers and bank transactions.
This is quick and easy to provide, presuming businesses have up-to-date bookkeeping. Online lenders then scan these documents and process predictions on whether they can make repayments, and predict their credit score. It’s no surprise that this method can be completed within 24 hours, when there’s no meetings involved, or the qualitative information that banks ask for.
This tech model is much more beneficial for the modern-day small business. Not everyone has time for lengthy meetings and business plans when they are in a cash flow predicament. Furthermore, they don’t want their credit score to be punished further when getting rejected by a bank loan.
In fact, they don’t want to be judged on their credit score full stop. Why should a business’s past credit decisions impact their current situation, if their current sales indicate repayments can be met? Online lenders are much more impartial and fair this way, in part because it’s all down to the ruthlessly impartial algorithm.
The regulations and immobility of banks
It’s not only banks’ lack of technological infrastructure that’s holding them back, but the dogma surrounding small business’ risk. Banks simply do not offer higher risk clients’ loans, even if it means at higher interest.
This is in part because banks are so large that it’s difficult for them to adapt to current technology and processes quickly, and instead opt for traditional methods. After all, their huge workforce has to be given some work to do in order to fill their countless, long-lease highstreet branches.
Because of the 2008 subprime mortgage crisis, where banks were lending money to homeowners that clearly could not make the repayments, there was some regulation and red tape introduced to put the onus of responsibility on the bank. Thus, they cannot have a high default rate or last year’s finances alone to make a decision. Online lenders do not have nearly as much regulation to comply, for good and for bad.
Some of this regulation has been undone recently, like seen in Australia, which should see banks slightly more businesses being approved of loans. However, high street banks are so large and with fixed legacy systems, they simply cannot adapt to changes quickly – both in their mentality and in infrastructure. Application processes may be cut down a little, but it will never compare to online lenders.
Banks and credit card companies are gathering more and more data. With this comes more problems for the average borrower. These large entities are using data processing in their own way, which is to determine interest rates and creditworthiness.
Whilst this may seem fair, it should be possible for people to separate themselves from their small business. If their Amazon sellers account is booming for 12 months now, why should their personal car repayments interfere? Our opinion on this isn’t important – what’s important is that there are 2 ways of attaining credit: the lengthy traditional way which is cheaper but more exclusive, or the fast, modern method that works on up-to-date financial information.
We wouldn’t want one to dominate the other out of existence, because the more choice for borrowers, the better. However, it will be interesting to see if the rising popularity of online lenders will push banks to find similar solutions of quick financing, and possibly even have options for those with average credit ratings. Australia’s change in regulation is something to keep an eye on over the next six months, and it could be a good example for the rest of the world.