Small businesses turning far more often to online lenders: Fed
Small-business owners are turning to online lenders for financing much more frequently than they did even two years ago, the Federal Reserve Banks found in a new survey.
Last year 32% of credit-seeking small businesses applied to an online lender, up from 19% in 2016, according to the survey, which was released Tuesday. Over the same period, large banks, small banks and credit unions all saw either steady application rates or a slight decline in interest from those same small businesses, which typically had fewer than 10 employees.
Those business owners are relying more heavily on online lenders even though they ultimately tend to be relatively dissatisfied with their choice, the survey found. Respondents pointed to high interest rates in the online lending sector as a key source of unhappiness. Annual percentage rates in the online business lending sector often exceed 25% and can be much higher.
Still, the findings suggest that more traditional lenders risk being left behind if they do not match the faster processes that many online lenders offer. Among small-business owners who applied to an online lender, the top reason cited was the speed at which they anticipated receiving either a loan decision or the requested funding.
“We can tell from the factors that they cite in their choice of lender that they prioritize speed far above cost and interest rate,” a Fed researcher who worked on a report that summarized the survey’s findings said during a call with reporters. The session with researchers was granted on condition they not be quoted by name.
By contrast, speed was not among the top three factors cited by business owners who applied to either large banks or small banks.
The survey, conducted in the third and fourth quarters of 2018, yielded 6,614 responses in the 50 states and the District of Columbia. The respondents spanned a wide range of industries.
Nearly three in four of the firms had fewer than 10 employees, while 71% reported $1 million or less in annual revenue.
In their advertising pitches, online business lenders often emphasize their speedy decision-making. “Business funding in as little as 10 minutes,” proclaims the website of the online lender Kabbage.
Meanwhile, traditional lenders offer annual percentage rates of 10% or less to small businesses with good credit profiles, but borrowers may have to wait more than a month to receive the funds. In response to the gap in customer experience, some banks have taken aggressive steps in recent years to offer a digital application process that matches what online lenders provide.
In the Fed survey, respondents who represented a medium or high credit risk reported being far more likely to apply to an online lender than those who posed a low risk. Many loan applicants pointed to expectations about their chances of being approved as a key reason that they chose an online lender.
And prospective borrowers are right to assume that they are more likely to be approved by an online lender. The approval rate at online lenders was 82%, compared with 71% at small banks and 58% at large banks, according to the survey.
The Fed’s data also suggests that online business lenders have loosened their lending standards, since their approval rate rose by 13 percentage points in two years.
“What we’re seeing over time is really what I would call a sorting of prospective borrowers,” a second Fed researcher said during the call Tuesday.
“We’re seeing essentially low-credit-risk firms going to very conventional channels, and lower-risk channels, ones that might have a longer wait time, but do offer better rates.”
The survey also contained new findings about the relative popularity of different kinds of online business lenders. Among small-business owners who applied to an online lender, 66% said that they chose a direct lender such as Kabbage or OnDeck Capital.
Companies such as PayPal and Square, which offer business financing to firms that use their payment processing services, proved less popular. Some 17% of business owners who applied to an online lender said that they chose a payment processor.