Lending Briefing: Alternative data powering SMB lending, and the top US consumer lenders
- Alternative data has been among the major driving factors for the rising interest in SMB lending, and fintechs are increasingly dominating the market.
- Marcus by Goldman Sachs has ranked highest among personal loan lenders in overall customer satisfaction, according to a new study.
Alternative data is powering SMB lending
Historically, the small business sector has been difficult to underwrite through traditional methods, but its complexities are starting to be understood through the power of alternative data.
SMBs are still struggling to get financing from big banks – only 15% get approved for a loan. They are regarded as high risk and expensive to underwrite, and credit reporting agencies don’t focus much on this sector. The data that was available mostly revolved around accounting and banking records.
But now there’s alternative data – information sourced from a variety of external resources, like market economic indicators, demographic data, POS transactions, website and mobile device data, and even satellite imagery.
Alternative data has been among the major driving factors for the rising interest in SMB lending. In 2020, the US was the largest market for alternative financing.
And it seems to be working - 83% of lenders who are using alternative data reported they were seeing benefits like allowing them to evaluate thin-file or no-file consumers, according to a recent TransUnion survey of 317 lenders and credit providers.
The use of alternative data has already been powering AI-based lending in consumer lines, allowing lenders to reach more borrowers. OppFi targets low income households, for example, using data points like online shopping habits and employment information to feed its AI model that automates the underwriting process. A similar mechanism could be applied to small businesses.
“SMBs in the U.S. spend more than $60 billion a year on electricity, according to Energy Star. All of this spend leaves a verified record of recurring payments that can contribute to an SMB’s credit file. Alternative lenders can use this data to fill the gap in the lending market,” said Sanjoy Malik, CEO at Urjanet, a global data provider.
Nowadays, a lender can find out a lot more about a business than its bank statement or credit score. It can connect to e-commerce accounts like Amazon or Etsy to check legitimacy and performance, and even drill down into the entire supply chain of the business.
There's a lot of unique data generated by these platforms yet to be unlocked – like how many projects were taken on, how many miles were driven, how many products were shipped, inventory levels, according to Jon Fry, CEO at Lendflow, an embedded lending platform focused on SMBs.
This leads the lending software to understand customers better than anyone else possibly could, because it processes all of the data generated by the workflows being run inside that business, he added.
“Instead of just the historical bank loan product, you're going to see custom tailored financial services, built within the workflows to all of these different types of businesses, at the right time and place when they need that money. That’s the really exciting part, because we're really just scratching the surface of what's possible there,” Fry told Tearsheet.
More tech savvy than traditional folks, alternative lenders and fintechs are increasingly dominating this sector, able to go into areas deserted by big banks. Alternative lenders had the highest SMB loan approval rate at 26.8% in April, up from 24% a year ago, according to biz2credit data.
Digital lenders like Upstart and Kabbage entered the market to expand access to credit by using alternative data, artificial intelligence, and machine learning algorithms to determine a borrower’s creditworthiness.
“At Kabbage, we got our start in automation, connecting our platform to third party data sources that our customers give us access to, in order to understand how their business was performing and their cash flow. I find it odd and surprising how people, banks, fintechs all still struggle to be comfortable with automation,” Kathryn Petralia, co-founder of Kabbage, told Tearsheet.
Square, PayPal and OnDeck are now among the biggest SMB lenders in the US. At PayPal for example, 70% of its loans are “going into regions of the country where banks have pulled out, sometimes for good economic reasons,” said Franz Paasche, senior vice president and chief corporate affairs officer at PayPal in an interview.
Banks are not big participants here, leaving a lot of opportunities on the table as “SMB lending will be not only one of the most economically important but also one of the most profitable contributors to banking revenues”, according to McKinsey.
Higher conversion rates and increased margins can boost revenues by 10-15%, while digitizing the customer journey and touch-time reductions can yield operational-efficiency gains of 20-30%, McKinsey found. By enhancing risk models and making decisions in a more consistent way, banks can reduce the risk of nonperforming loans by 10-25%.
More banks want to start serving the small business sector, looking to add invoicing and payroll processing to their services. But digital engagement is mandatory to reach this segment, and cutting-edge modeling techniques coupled with alternative data are huge differentiating factors – plus fintechs have a competitive advantage here.
But perhaps partnerships could be a way forward – certainly the case for Marcus by Goldman Sachs. The bank partnered with Nav, an SMB financing platform, to allow qualified small businesses on Nav’s platform to apply for lines of credit.
Nav also leverages machine learning to pair business owners with some of the best available lending options, connecting real business data to lender criteria.
There is certainly room in the market, and with the flurry of lending-as-a-service providers around these days, more financial institutions should be able to find a solution that works for them.
Chart of the week
Marcus by Goldman Sachs has ranked highest among personal loan lenders in overall customer satisfaction, according to a new JD Power study. The survey measures this based on performance in four factors: application, loan management, shopping, and terms.
The winning strategies with personal loans is a clear understanding of the different needs and expectations of their target clients and optimally invest resources to meet or exceed the expectations of those different groups, according to Tom Lawler, head of consumer lending intelligence at J.D. Power.
What we’re reading
CFPB won’t let lenders hide behind algorithms (Banking Dive)
JPMorgan Finds New Use for Blockchain in Trading and Lending (Bloomberg)
Klarna partners with Marqeta to launch Klarna Card (Crowdfund Insider)
Financial-Technology firms tap AI to reach more borrowers (WSJ)
36% of consumers earning $250K+ now live paycheck-to-paycheck (PYMNTS)
What we’re writing
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