Jamie Dimon warned in JP Morgan Chase's 2014 annual report that "the Silicon Valley is coming." Silicon Valley startups are chasing every profitable part of a large commercial bank. Apple is chasing after interchange from credit card payments. Lending Club and SoFi are attacking consumer lending. Money transfer is under attack on multiple fronts. If you want to send money internationally, TransferWise and Xoom are ridiculously cheap. If you want to send money to your friends, use Venmo. Why pay for investment advice, when you can invest with Betterment or Wealthfront? Even boring deposits are under threat from online banks like Ally.
These digital challengers are not offering products that are a little bit better. They are offering products that are dramatically better. SoFi offers personal loans at low single-digit rates, while traditional credit cards charge 12% or more. TransferWise will let you send money to the UK for as little as $1, compared to a fee of at least $25 at most major banks. And Ally is paying 0.99% on savings accounts, when you can only get 0.01% at Citibank. Consumers generally had very little love for their banks. Not only are startups creating better user experiences. They are creating products with dramatically better value. Jamie Dimon is right to worry.
One area that has seen particularly dramatic growth is small business lending. It feels like every week a new lender targeting small businesses is being launched. MagnifyMoney (my website) did a survey of the market and found no fewer than 17 lenders, and counting. And loan volume is growing rapidly. Disruptive small business lenders are poised to grow rapidly for three key reasons:
- After 2008, many banks tightened underwriting standards and starved long-time clients of credit when they needed it most. If there was every any love in banking relationships, it was lost after 2008.
- The application and underwriting process at many leading banks remains document intensive, confusing and worthy of a Kafka novel.
- Small business lending remains the last frontier for automated, advanced analytics and risk underwriting. And some very smart people are making that a reality.
If you are a small business owner looking for a loan, you may want to consider speaking to someone other than your local bank manager. Not all of these startups will survive. But while they are all competing for your business, you may be surprised at how easy it has become to get a large loan quickly.
Your cash belongs to you, not your bank. Fintech startups are challenging the big banks—and already saving people thousands.
Credit Tightening In 2008 Was Painful
When the financial crisis hit in 2008, banks immediately started tightening credit. Many small business owners received rude shocks in 2009 and 2010. Rather than renewing their lines of credit, banks forced businesses to go through a much more rigorous and document-intensive renewal processes. Many businesses were rejected outright or had their lines cut. I have met with many small business owners who viewed the annual line of credit renewal process as routine, until it was no longer routine.
Pulling a working capital line of credit is particularly challenging for a small business. In an economic downturn, sales are expected to decline. But by eliminating reasonably priced credit, many businesses were forced to shrink inventory or borrow at much higher rates, which hurt earnings. I have interviewed a number of small business owners who turned to startup lenders. And most of them switched because their banks stopped lending. The story was familiar. After being told that they could no longer renew their line of credit, they went onto Google to see what options were out there.
Many of the current small business lenders were born to fill the gap left by bank retrenchment. And once small businesses experienced how much easier it was to borrow money from the new lenders, they never turned back.
The Application Process Remains Confusing
Applying for a small business credit card at a bank is incredibly easy. Banks have automated the risk decisioning process and can approve lines of credit quickly. However, when small businesses want loans or lines of credit that are much larger than the typical credit card limit, they step back in time. Banks regularly ask for a lot of documentation and tax returns. The underwriting process feels like a combination of confusing rules and human judgment. And banks have never been good at adding transparency to the underwriting process.
The new batch of Silicon Valley startups are looking to create a simple, transparent and easy process. Depending upon the size of the loan and the lender, you can get your money the same day. And when it takes longer, the transparency in the process can be much better than traditional bank processes.
New Credit Risk Underwriting
The new crop of lenders are now starting to use alternative forms of data to automate a historically judgmental process. For example, Kabbage allows small business owners to link their financial statements (via QuickBooks), their bank accounts, their LinkedIn profile and their credit card acceptance data during the application process. Rather than waiting for a loan officer to read a tax return and fill out a form, the algorithms at Kabbage can quickly determine the stability of the revenue, the quality of the cash reserves and the diversity of customers. The scoring algorithms will only become more sophisticated over time. In this new world, businesses with good accounting, strong bank balances and digital sophistication will be rewarded.
All Is Not Perfect Online
Small business borrowing remains expensive, even with many of the new small business lenders. Although your local bank may be painful to deal with, it will still often be cheaper than the new lenders. The new lenders are still perfecting their lending models, which will take time. New customers to the lenders often come because they were rejected by their banks, which adds adverse selection. And fraud risk remains real for online lenders, especially when loan amounts are high.
Not all of the new lenders will survive. But there remain two obvious use cases for the new lenders. If you need money quickly, due to an unexpected emergency, it will be hard to find a faster solution than some of the new companies. And if your bank has been painful to deal with, you might find the experience with one of the new lenders better. If the new lenders are able to reduce pricing, banks will really start to feel the pressure.
