Barely a day goes by without a new headline about online lenders and their potential to disrupt or displace traditional lenders. First there were the high-profile IPOs of Lending Club and OnDeck late last year. Then came JP Morgan's CEO Jamie Dimon's well-publicized warning that "Silicon Valley is coming." And, more recently, a handful of online small business lenders were asked to testify before the House Small Business Committee on Capitol Hill.
With all this media excitement, one might assume that marketplace lenders—as they've taken to calling themselves—already represent a huge piece of the overall small business lending pie, and pose an imminent threat to credit unions and other traditional lenders. In reality, though, this is an emerging industry still trying to find its footing while bringing new technologies to bear on one of the biggest problems facing our economy today.
The Small Business Lending Problem
Small businesses have historically accounted for roughly half of the nation's private workforce and create two out of three net new jobs annually. It is no exaggeration that their strength is important for our entire economy. However, although the U.S. economy has pulled itself out of the last recession in most respects, overall lending to small businesses still lags approximately 17% to 18% below its pre-recession peak.
Best industry estimates place small business online loan originations at around $10 billion since the inception of the marketplace lending industry in 2007. Back-of-the-napkin math says that's a little over $1 billion a year. To be fair, most of this $10 billion has come in recent years and growth has been accelerating. By comparison, as of December 2014, credit unions had approximately $52 billion in business loans on their books and business lending activity for credit unions has grown at an average annual rate of 9.6% over the past three years. Simply put, credit unions originate more small business loans in one year than the entire marketplace lending industry has since its inception.
Improved User Experience
Given their relatively small impact thus far, why is there so much excitement around online lenders? It stems largely from the fact that these companies have managed to improve the user experience for borrowers more than anyone else has in nearly a century. By using the latest technology to simplify the application process, make the application mobile accessible and offer nearly instantaneous lending decisions, these platforms have set a new standard. And for small businesses, this streamlined process is a major game changer. It reduces time spent searching for loans (small businesses typically spend anywhere from 24 to 36 hours) and the headaches of applying to multiple lenders only to get turned down weeks or months later.
Small business owners seem to be so pleased by this improved experience that they will accept exorbitantly high interest rates charged by these lenders, which often can range as high as 30% to 300% annually, worse than trying to fund a small business with a credit card. Still, many borrowers love this new breed of lenders and regularly give them loyalty and satisfaction marks on par with some of the best known brands (and higher than credit unions as an industry). According to the Joint Small Business Credit Survey Report, 2014, 18% of small businesses said they applied for credit from online lenders in 2014, and that number is expected to grow higher this year and into the future.
It's More Than User Experience Alone
Online lenders have succeeded at showing the promise of technology in addressing small business lending challenges. But it's not as simple as launching an app to circumvent the existing industry and regulations. Improving small business lending in our communities is complicated and requires sufficient, low-cost capital to give small businesses access to the funding they need at affordable rates.
Online lenders do not currently have the customer base or access to the amount of low-cost capital needed to support small businesses in this way. And the kind of growth required before they could even hope to help close the enormous funding gap is years, if not decades, away. As a result, online lending does not currently operate at the scale or in the ways small businesses need. To the extent businesses use peer-to-peer lending, the "peers" have to be institutions with the balance sheets and patience to support them, rather than idiosyncratic groups of investors looking for quick, high yields with a minimum of capital at risk. Just think about the potential impact on small business lending when investors find higher yields somewhere else or lose their appetite for these loans altogether?
Low-Cost Capital & Technology Needed
Because of the magnitude of the problem that exists in small business lending, credit unions and other traditional lenders are the only ones with the balance sheets capable of solving this issue now. And given developments in computing and the explosion of business data, it is a problem they can solve now.
Most immediate, credit unions can partner with technology companies to employ the latest financial technology that will give small businesses the customer experience they've come to expect. They can upgrade lending operations in a way that both improves the borrowing experience for their members and makes even small dollar-amount loans (particularly those under $50,000) profitable to offer at reasonable interest rates. And they can utilize new approaches to analyzing data that will help them to better understand their members and their businesses—so good borrowers are not rejected for arbitrary reasons. By taking this path, credit unions can continue doing what they have always done: supporting members and small business in their communities.
Although I expect that online lenders will continue to bask in the media spotlight, 2015 is shaping up to be the year that credit unions will start making serious moves to innovate their small business lending practices on par with these lenders and provide the improved customer experience members expect. This is their year to take advantage of the extraordinary market opportunity presented by advancements in financial technology and provide the small businesses in their communities with streamlined services and greater access to affordable capital.
Trevor Dryer is the CEO and co-founder of Mirador Financial, a small business lending platform for credit unions and banks. He can be contacted at 503-451-0518 or via email at email@example.com. For more information, visit miradorfin.com.