Alternate Lending Post COVID-19: Better Models For SMB Lending

The economy is slowed down due to the ongoing Covid-19 pandemic. With many losing their jobs and daily livelihood, the novel COVID-19 has a profound impact on global trade and business.   

And, with many countries dealing with various stages of lockdown or loosening the restrictions, it is evident by now that the virus has majorly impacted the small and medium businesses.   

International Trade Centre’s 2020 SME Competitiveness Outlook highlights, lockdowns in China, the European Union, and the United States have had the most significant impact on trade.  

Together these three economies account for 63% of world supply-chain imports and 64% of supply-chain exports. The report estimates that the global disruption of these manufacturing hubs will amount to $126 billion in 2020. 

Moreover, most of the SME’s witnessed a drastic drop in revenues, and many quoted that they would run out of business with the cash flows they are currently in. 

This led to massive demand in SME loan requests and ingested a massive pressure on the world of SME lending – banks, merchants, and mainly on the alternate lenders (Tech companies) offering individual and SME loans. 

Due to mounting loan requests and disbursals, the alternate lenders were facing immense distress due to COVID-related delinquencies. 

As a result of growing pressure concerning delinquency rates, Amex announced it would acquire Kabbage for $850 million, while Enova announced it would acquire OnDeck for $90 million; both acquisitions were facing distress, as delinquencies pile up due to COVID-19. 

Meanwhile, Stripe Capital launched lending partnerships with Lightspeed to offer U.S. retailers up to $50,000 to meet business goals, as well as with the Home Business Service software provider Jobber. 

While COVID may have been a catalyst, these events reflect a crucial shift in online SMB lending. 

Before proceeding any further on why these models are better, let us understand more about Alternate Lenders. 

Let’s dive right in. 

An Introduction to Alternate Lending

Alternate lending is a process of lending money through digital platforms. The American Banks Association deemed it as a natural evolution of banking.  

It is also known as peer-to-peer lending, and marketplace lending through a digital platform that uses non-traditional data.  

The lenders use the borrower’s data and data from third parties, which is passed on through an algorithm to calculate the risk score, and based on this risk score, the lender decides whether to approve or reject the loan.  

In terms of the target offerings, it is pretty much individuals and small & medium enterprises that are underserved by traditional financial institutions – for example, students and small companies with less than one year of operation. 

Now with that being said, let’s look at the core competencies that alternative lenders possess in comparison to a traditional bank. 

Alternative Lenders Core Competencies

The alternative lenders or lending products are the future of low-end loan applications. Compared to the banks, the overall loan application process is simple and induces a superior customer experience.

Some of the core competencies of alterative lenders are

• Strong Customer Experience
• Simplified borrower application process
• Use of big data & analytics
• Lower cost of operations
• Real-time underwriting of borrowers

Online marketplace lenders like Kabbage, OnDeck, and Funding Circle entered this low-end loan application market a decade ago and digitized the overall application process and started connecting the data sources with third-party applications like Quickbooks.

However, the inability of a few loan borrowers to repay and credit evaluation process concerning the credibility of underwriting of some alternative lenders impose a possible threat at these concerning times for the future of the industry as its hurting the overall sales (Loan book).

As per reports, delinquency rate of OnDeck jumped to 45% post-COVID-19 from 11% and was pushed to increase the reserves to accommodate the credit losses.

A research conducted by JP Morgan quotes, “The median small business holds 27 cash buffer days in reserve”, which in turn puts considerable pressure on the business operations.

Moreover, the success to failure rate of small & medium businesses is not so favorable to online lenders. According to the U.S Bureau of labor statistics, one of five SME’s or businesses goes out of business in the first year. And this rate is even higher for businesses in need of loans, which makes this industry economics riskier for the SME lenders.

Though the U.S. Government’s PPP (Paycheck Protection Program) helped ease the payroll and overhead cost of many small businesses, it still didn’t cover all the expenses. This is because though the cost of origination and servicing small loans is somewhat comparable to larger loans, but the interest and fee revenue is far lesser.

Besides, the online lending model majorly works on riskier borrowers who are denied loans by other lending institutions – banks, credit unions, or community banks.

As a result of not diversifying the product line, the SMB or SME lenders feel the heat during the recessions.

Whereas, a bank can tackle the turmoil because of a well-diversified product portfolio and the base of deposits accounts, with SMB lending just being a part of overall portfolio offerings.

Now, coming back to the shift in the alternative lending landscape. Let’s understand how it will emerge post-COVID-19 and why this model of acquisition is better for SMB and Alternate lending.

Let’s dive right in.

Better models for SMB & Alternate Lending

Post the Covid-19 era, we will see three models that will majorly focus on building superior customer experience by engaging with the existing customer base for offering the SMB loans.

Are you excited to know what changed the Alternate Lending landscape? Then the next 3 minutes is for you.

Keep reading.

1. Embedded Loans

With COVID-19 impacting physical contact, touch, and interactions, most transactions are still going to be online. In order to diversify the portfolio, the SME lenders are partnering with software providers to scale the loan book.

In simpler terms, embedded loans are lending products that are attached to the software which already the SMB customers are using as an operating system.

One example of the embedded loan is the Stripe model, which was launched this month. The core idea behind partnering with Jobber & Lightspeed is to leverage their customers, who, in turn, are also their potential customers.

Some of the benefits of Embedded Loan Model are

• Cost of customer acquisition is zeroed
• High visibility to lender and remains top-of-mind
• Simplifies customer journey with high engagement software products like day-to-day clientele via Jobber or Lightspeed’s point-of-sale
• Ultimately helps provide a smooth lending process and, in turn, gain strong customer relationships

2. The Bank Partnership Model

In this model, the bank & digital lenders, with or without a licensing agreement, start offering SME or individual lending in addition to the other high engagement financial products. For instance, payment processing or a checking account.

One such example is Square, which started as a POS (Point of Sale) payments product and later started offering lending products.

In the bank partnership model, the overall lending experience is again very subtle. Few other benefits of the bank partnership model are

• Avoids adverse preselection of loan customers
• Enough data to evaluate customers spending patterns and credibility
• In the case of Stripe & Jobbers model, it provides additional data points like inventory management to predict rick much better
• Eventually, avoiding the negative experience of loan denials with the help of additional data points like inventory management

Now, let’s look at the last model of Alternate Lending.

3. Smaller loans of shorter duration

The alternate lenders are marching towards the smaller loans with shorter durations. This is because of the lower risk than an SME or SMB lender – Like Funding Circle or OnDeck. This model is also known as the Merchant Cash Advance. (MCA)

Square, Stripe, and other online lenders have started to offer smaller loans or “advance,” and receives the capital back as installments daily from the sales generated by the SMB until the capital amount is recovered. (With a fee added upfront instead of typical interest payments)

Moreover, smaller loans can help predict the creditworthiness of the borrower and, in turn, can offer larger loan amounts.

Additionally, the digital & online lending growing multifold in the COVID & Post-COVID era brings a massive volume of financial and personal data of customers, making them attractive targets for cybercriminals.

It becomes even more critical to secure the digital ecosystem by binding together the quality aspect of the online lending platform.

Let’s look at the next steps that an SMB or Alternate Lenders should focus on.

The Next Steps for Alternate Lenders

We can rest assured that digital lending is the new normal after the pandemic. With the increased online transactions and digitization of loan applications, it is even more vital in delivering the brand promise – as more and more traditional lending shifts to online and mobile channels.

It is important to do a periodic quality audit of the customer interface to avoid negative experiences and helps you in understanding:

• Ability of users to complete tasks in your website and apps
• Is your application usability aligned with your business goals
• Analyzing your site or app interface for user-centered improvements
• Enhancing the cybersecurity posture

Parallelly, leverage technologies like biometrics, credential management, restricted access, network monitoring, and rapid isolation of intruders to secure the digital platforms. This becomes very important in order to gain customer’s trust and loyalty in an industry where it matters the most.

Finally, though the SMB lending seems like it is collapsing, in reality, it is strengthening its presence with the new models. Combined with a simplified lending application process, faster approvals with the use of big data & analytics with an economically viable business model that hopefully weathers the next storm.