Digital Banking Is Revolutionizing Banking Industry

The percentage of retail bank customers who access banking services daily via desktop apps has nearly doubled during the COVID-19 pandemic, according to BAI, a banking association. Rather than risk the possibility of a viral infection, many consumers are checking out ways to do their banking that don't involve in-person trips to a bank lobby. This is especially true for small businesses that aren't eligible for a Paycheck Protection Program (PPP) loan.

 If you haven't already made the switch, you should know that your options are multiplying. "Alternative lenders are emerging at a feverish pace," noted a pre-pandemic report by Moody's Analytics. Among other things, that report identified several stumbling blocks that small businesses commonly encounter when looking for credit, such as:

• Lack of knowledge of their credit risk and how they can improve their business credit standing,
• Opacity of banks' credit assessment process and expectations, and
• Inconsistent requirements among banks in terms of the lending process, necessary data and documentation.

Drivers of Change

The report identified the following three key factors driving the evolution of small business lending services:

1. Tools that automate gathering and structuring of small business data from financial statements, tax returns and other documents,
2. Development of credit models using data and elements beyond financial information and broader use of all data sources to optimize decision-making, and
3. Enhanced early warning, loan portfolio monitoring and business intelligence capabilities.

Those resources make it possible for lenders to extend loans to companies that might not meet the underwriting criteria of traditional lenders. "Companies experiencing either high growth or unexpected deterioration can benefit from relaxed covenants, interest-only periods and collateral-lite structures that are common in non-bank loan structures," according to Cerebro Capital, a self-described "commercial loan platform."

A recent survey Cerebro conducted of nonbank lenders found that 76% of respondents "expect loan demand to surge over the coming months as borrowers leave commercial banks in search of relaxed covenants and flexible loan structures." (Note: Most of those lenders work with middle-market companies seeking loans of at least $2 million.)

Small businesses that are experiencing neither high growth nor unexpected deterioration are also benefitting from the explosive growth of nonbank lenders that leverage advanced financial technology solutions (fintech). Increasingly, traditional banks are also taking advantage of fintech.

Harnessing AI 

Luna Connect is a fintech solution provider that serves traditional financial institutions and nonbank lenders. They explain that artificial intelligence (AI) is at the heart of the matter.
 

With AI, a computer is programmed to teach itself through experience and understanding patterns. According to Luna, AI-powered digital lending platforms can "gather banking data for verification, perform credit decisions using AI and promise faster disbursement."

Also, credit decisions increasingly are based on a wider range of available data than previously. One lender, Benetrends Financial, reports that the emerging "full-spectrum" methodology "seeks a more robust picture of the overall credit behavior of an individual entrepreneur or a growing small company." To do so, they look at everything from the company's "payment of monthly bills, the use of online borrowing, inventory turnover, and overall profitability as a measure of creditworthiness."

AI has also enabled nonbanking companies — such as mega-retailer Amazon and payment-processing companies PayPal, Square and Stripe — to leverage their access to data from merchant customers to go into the lending business.

Nonbanking companies can use automated analysis of multiple factors, including account history, sales, customers and revenue growth, to determine which business fits its general lending criteria and make prompt lending decisions. Often, merchants are invited to seek a loan based on the lender's advance knowledge of their creditworthiness.

Seeking Eligible Borrowers

"Our sophisticated tools are running every single day to find sellers who would be a good fit" for its loans, states one of the large payment processing fintech companies. The firm has already lent over $1 billion to more than 100,000 small companies.

Another top player in that field boasts that its loan applications take only five minutes to complete, and lending decisions and funding of approved loans are made in less than a minute. Instead of incurring periodic interest charges, borrowers pick a percentage of sales processed by the fintech company that the firm can deduct from the payments it processes, and that determines the amount of a fixed borrowing fee.

For example, let's say you borrow $100,000 and agree to paying a fee of $4,000. The fee is recouped by allowing the lender to keep 30% of payments it processes on your behalf, until the fee is paid. If it takes a year to generate enough sales to cover the $4,000 fee on a $100,000 loan, then the annualized interest rate would be about 4%. If sales are such that the lender recoups its loan much faster than a year, then the annualized cost would be proportionately higher than 4%. 

Variable Pay Plans

Suppose, instead, that you opted to allow the fintech company to skim only 10% of your sales that it processes. In that case, it would take the lender longer to recoup the loan than in the previous example. So, the lender would require a fixed fee that's considerably higher, perhaps three or four times as high.

Other variables impact the size of the fixed fees, such as your business track record with the fintech company and the size of the loan. Unlike many traditional small business loans, this fintech company doesn't require a personal guarantee of payment by the business owner.

There is no "free lunch," however. The greater the credit risk, the higher the interest will be, whether you're borrowing from a fintech company or the bank down the street.
 

Meanwhile, traditional lenders recognize — and are responding to — the threat posed by fintech companies. One analysis of the small business lending scene recently commented on the "unlikely union" of traditional banks and fintech companies. Fintechs have contributed AI-powered fast credit extension decision-making, while banks bring their "large databases of user data and custom loan products to the table."
 

In that analysis, the conclusion is that "by combining these strengths, a new era of small business funding is slowly budding."

Final Thoughts

Even in a tough economy, technology has opened the options tremendously. Not only is there a growing array of lenders but also a virtual buffet of convenient possibilities, from the privacy of home if that's what you choose. And that increased competition causes traditional lenders to fine-tune what they offer. It's a win for lenders and small business borrowers alike.