Due to the ubiquity of smartphones and computers, businesses are doing more things online than ever before. When it comes to e-commerce, the impact has been widespread and well known; people can browse, compare, and purchase items through digital channels. Less discussed is how the digital revolution has impacted the credit industry.
Online lenders are increasingly meeting the needs of small and medium sized enterprises (SMEs). An estimated 26% of small businesses secured loans through alternative online lenders in 2019, according to Mercator Advisory Group’s 2019 U.S. Small Business Payments and Banking Survey.
There are many reasons that an SME would seek out alternative online lenders. Part of the appeal is that online lenders are more likely to provide funding than traditional banks are.
Since smaller businesses have historically had less access to liquidity, alternative lenders have stepped up to meet their needs, explained Steve Murphy, director of Commercial and Enterprise Payments Advisory Service at Mercator Advisory Group. “This has been particularly true since the 2008 financial crisis, as banks reigned in small business loans.”
Part of the problem is that traditional lenders have often relied upon state-sourced data and credit bureaus to make a crediting decision, meaning that many businesses don’t meet the stricter lending standards. Murphy explained that since alternative lenders add more factors into the decisioning process, including transaction data, small businesses have more access to credit.
“By using online forms and broader swaths of non-traditional data—not just financial statements and credit scores—then running machine learning algorithms for fast credit decisions, alternative lenders are filling in the lending gap,” said Murphy.
Alternative online lenders make lending easier
According to Mercator’s small business survey, 43% of businesses reported that their main reason for using alternative online lenders was because “it’s easier to apply online than dealing with a traditional bank or credit union.”
There are multiple reasons why small businesses find this process easier. An informative blog post from Wirecard is worth the read as it summarizes many of them. The author notes that online lenders “drastically reduce wait times for loans, offering flexibility to businesses that need to increase their cash flow as soon as possible.”
This is essential for small businesses because, as any small business owner knows, they often have cash flow problems. The average small business only has 27 days of cash flow on hand, according to a report.
The Wirecard blog notes that while the speed with which a loan is approved is important so, too, is the speed with which the money is available to the business. “This has led to the growth of Merchant Cash Advance (MCA) companies, which help undercapitalized businesses act quickly on challenges and opportunities,” wrote Kevin Brown, author of the Wirecard blog.
Many lenders currently rely on the ACH Network or wire transfers to pay out loans, two methods that are relatively quick. However, the ACH Network can take 1 to 3 days to process, and wires can take 1 to 2 days. For companies looking for immediate access to funds, this delay could prove problematic.
Luckily, there are real-time payment options that would benefit both businesses and lenders. And as consumers become more accustomed to speedier payment methods, lenders who provide such a service will attract more customers, especially millennials.
Millennial small business owners, who are twice as likely as older ones to seek alternative online lending, due so primarily for the speed afforded by online lending.
Issuing funds via digital cards benefits all involved
The Wirecard post explains how lenders should consider issuing funds through virtual cards for a variety of benefits.
The first is data related. The lender can access a trove of valuable information on the borrower’s spending habits when the loan is made via a digital card. This allows lenders to gain a deeper insight into the challenges, needs, and risks faced by the borrowing small business.
Armed with more information, lenders can improve their risk management models, helping them “determine whether and how much to lend, as well as what loan terms to set.”
The use of virtual cards can also help lenders avoid the fees associated with issuing funds through ACH or wire, which typically cost over $1 per payment. Wirecard points out that in addition to avoiding paying this fee, lenders who use virtual cards can “gain the opportunity to share revenue with their payment processor on interchange fees generated from card use.”
Virtual cards can also create a better customer experience. “These types of cards work well because they enable online purchases in a shielded environment,” said Brian Riley, director of Credit Advisory Service at Mercator Advisory Group. “Instead of putting your everyday credit card number out on the internet, you can create a unique number with a prescribed credit limit, and transact with the virtual card.”
He predicts that in the coming years, there will be a lot of innovation in the virtual cards space.
Online lenders are poised to take advantage of this innovation, especially those implementing digital payment options. Competitive lenders will be those who offer speed to customers, harness data, and explore new sources of revenue.
To learn more about alternative online lenders and virtual cards, you can read the Wirecard blog post here.