Right now, financial markets all around the world are being roiled by the ongoing coronavirus (COVID-19) pandemic. It's a fluid situation with an uncertain outcome, and nobody's quite sure what the long-term economic effects will be. The only things that seem certain are that stock markets are currently choosing to all but ignore the pandemic, while rank-and-file businesses continue to post troubling results.
The underlying data, though, indicates that major economies are already in recession. And given that the cause of those recessions has no end in sight, there's good reason to believe that small businesses, in general, are going to start needing cash infusions soon if they are to stay afloat. That puts the spotlight squarely on the financial sector, which is going to have to provide the liquidity those businesses need to survive.
The trouble is, the traditional financial sector isn't that great at providing the kind of assistance that's required. One need only look at the troubled rollout of the Federal Paycheck Protection Program (PPP) loans to see why. Big banks and other large financial institutions just aren't built to be agile, and they're known for being difficult for small businesses to work with even under normal circumstances.
That's just where a legion of fintech companies are hoping to lend a hand. Already, there's a growing list of them stepping in to fill the small business lending void created by big banks. Here's a look at how they're doing it and how it's going to change small business lending forever.
Big data for lending decisions
One of the ways that fintech lenders are hoping to get cash flowing to small businesses is by using a new kind of loan approval process. They're making use of big data to enable quick lending decisions based on factors beyond traditional credit scores and prior lending histories. On the front lines, well-known fintech firms like PayPal, Square, and Intuit have already gotten approval to join the PPP, giving them the chance to prove they can reach small businesses that the big banks couldn't – or wouldn't.
Those firms are leveraging the data they already have from their business customers to gain critical insight into the pre-pandemic health of loan applicants. For example, PayPal can use the average cash flow passing through a business's merchant account to decide if a business is creditworthy, while Square can do the same using the data collected by its payment processing terminals. Existing customers of these firms – who tend to be small businesses – have a big advantage in the application process.
But the biggest standout of them all so far has been Funding Circle, a 10-year-old London fintech that has long specialized in small business financial products. According to the firm's representatives, their system can process PPP loans in as little as three days, and they have enough cash reserves to make up to $250 million in loans each and every month.
Changing traditional lending from the inside
Another way that fintech firms are working to serve small businesses is to provide the kinds of tools traditional banks can use to facilitate lending to them. That's the goal of firms like Cignifi, a Boston-based financial services AI developer. Their platform aims to provide lenders with alternative means of scoring loan applicants who don't have a long-established credit history. It does so by analyzing the mobile phone histories of applicants, and it's seen significant successes in real-world use in developing markets.
But Cignifi's platform would also make an excellent means of assessing the creditworthiness of the estimated 25.7 million one-person small businesses operating in the U.S. They're some of the most underserved businesses in the nation when it comes to financial services and access to credit, often operating under the radar of traditional lenders. For that reason, banks are starting to come around to new scoring methods like those offered by Cignifi – much to the relief of anxious small business loan applicants.
New lending relationships
Offering a generally lower barrier to entry than traditional lending methods, these fintechs are giving those working with small and medium businesses opportunities that some traditional lenders might shy away from.
However, there is a caveat. Some small and medium businesses might find fintechs willing to work with them, but at higher premiums than traditional lending partners might. Fees and interest rates may look less attractive at first when compared to traditional lending options, but this is the price to be paid for a generally lower barrier to entry than required by traditional banks and other old school lenders.
As a new and burgeoning field, it remains to be seen how fintechs will cultivate their lending relationships with small and medium businesses.
On the one hand, the technological aspect of the business offers the possibility that these services will be faceless lenders – money machines businesses can tap through a web interface when they need to.
Or, perhaps FinTechs will take a few pages from traditional lending strategies and seek to cultivate personalized relationships with their clientele, working to tailor lending options and offering reliable businesses attractive lending options.
Whether a fintech behaves as a close lending partner or as a streamlined means of getting small credit will be up to the structure of each specific company, and will be an important factor to keep a close watch on as fintech lending continues to gain ground.
Gaining long-term market share
Although it's still too early to tell how much of a long-term impact the current generation of fintechs are going to have on business lending, the early returns are promising. Take, for example, the fact that fintech lender Kabbage is presently the third-biggest PPP lender by application volume and is working in partnership with 135 different community banks. It offers a powerful example of how industry upstarts can capture significant portions of the small business lending markets if they make the right connections in the traditional banking industry.
And that new reality is excellent news for small businesses because it points to a future where they'll have a much easier path to securing loans and credit. In fact, the more successful today's fintechs are at delivering loans to small businesses, the more options those borrowers will have moving forward, because traditional banks will have a record to use in future lending decisions.
There's a good chance that the small business lending space won't ever go back to its pre-pandemic configuration. That's because each day, a bumper crop of new highly-skilled fintech innovators are bringing new approaches to lending to market, and the incumbent businesses look like they see the writing on the wall. At last count, 60% of credit unions and 49% of banks in the U.S. reported interest in forging partnerships with fintechs. And judging by the success so many of them are having serving small businesses during this once-in-a-lifetime financial maelstrom, we could be witnessing the birth of what will become an all-new small business lending ecosystem for the 21st century – and not a moment too soon.