Why Banks Aren’t Lending’s Dead End

The last 12 months have been good for alternative financial services. And this is quantifiable from a variety of vantage points. A decade ago, alternative financial services was mostly a euphemism for seeing a quasi-reputable, or in some cases totally irreputable lender. In the last year alone, it has become the provenance to two $1 billion-plus IPOs (OnDeck and LendingClub) and in the last 60 days it has minted a new entrant to the unicorn startup club (Prosper).

And while Prosper is the latest alt lending unicorn – it surely won’t be its last. In the 20 weeks of 2015, our Innovation Investment Tracker shows us that Alternative Financial Services has been in the Top 3 categories for investor interest for 14 of those weeks – or 70 percent of the time.

The reasons for that enthusiasm are well known – they quite simply fill a need. A need that a whole host of enterprising innovators have filled – using technology to accelerate the process.

“We’ve provided a billion dollars in financing to around 20k or so business owners who’ve made 35k transactions,” Merchant Cash and Capital founder Stephen Sheinbaum told us. “The reason we have been able to fund so much over the years is that we are so technologically driven  – we’ve automated the underwriting process and merchants have the ability to come onto our funding platform and go through an automated underwriting process. They can be approved for a deal in a matter of minutes. And we are doing in minutes what used to take days or weeks at the banks.”

And used data to bring “uncreditworthy” people into the mainstream…

“We debunked that traditional view that they’re just a group of people here who are not creditworthy. That happened to be Hispanics, immigrants, who were hard-working but without a credit score. And because they lacked a credit score, banks didn’t have enough data and declined them out of hand. With big data we found a way to approve them and have low losses,” Insikt CEO James Gutierrez told PYMNTS.

So while there’s much to love about alternative lending and what it brings to the marketplace – a senior banking official who didn’t want to be named, recently told PYMNTS that the cries that alternative lending will soon replace traditional lending and become the “new traditional” is possibly a bit ahead of itself.

“I think this gets presented that it’s banks against the ‘new’ lenders – which from the point of view of their marketing makes a lot of sense – they are the ‘newer, smarter, faster’ way to deal with lending for small businesses and consumers,” the official stated. “Which is absolutely true in some cases. However, their advertising is a bit less interested in also noting what it is – which is the costlier way to get credit.”

They noted that some alternative lenders charge interest rates that, on average, annualize at around 20 percent – and that on various lending platforms, interest rates in excess of 20 percent are actually fairly common.

“But again – when you look at these businesses, it might be a little unfair to even talk about  annualized interest, because these services are writing loans that are smaller in amounts than what banks are going to be able to efficiently underwrite – so they are paid off faster,” they said. “Or the loans are intentionally structured to be paid and adjusted monthly, so trying to calculate annualized interest gets confusing.”

Mostly, the official said, the lesson is not so much that alternative lenders are going to fundamentally change the face of lending, so much as they are going to help expand the corporate and consumer base of “desirable” customers. That is an achievement – and one the individual thinks that larger banks can learn from.

But ultimately, the official believes that mainstream lenders are going to stay popular with “mainstream” borrowers for the foreseeable future.

“I think we speculate on whether alt lending is going to replace bank lending, or regular consumer products on cards. Now I work for a bank – but honestly I do think there are customers that alternative lenders do better with, especially those who are new to credit markets. At the end of the day for a prime borrower, a traditional lender is going to offer the least expensive product when it comes to interest – and that is compelling.”

Ah, the operative word – “prime.” Remember the old joke about banks only lending money when the borrower doesn’t really need it? Even that was tough during the financial crisis. And that is why alternative lenders emerged. If businesses didn’t need the money and if banks loaned them the money, there would be no need for them to exist.

When the choice is between a so-called “expensive loan” to smooth over cash flow or invest in growth, or no loan and all – the answer is obvious.

“I think it is in everyone’s interest to see access to financial services expand. I don’t think all methods will work as well as others – and I think what will make the market interesting in the next five years will be watching the which models work, and which don’t.”

PYMNTS will be watching, too.