Fed: SMEs are dissatisfied with online lenders
Following the Great Recession, small businesses struggled to get loans through banks – and even when they were available, the common complaint was that the application process was slow, time-consuming, paper-intensive and inefficient. tailored to the needs of small businesses.
From this gap emerged a group of alternatives for underwriting access, which varied widely in terms of structure, funding sources and target demographics. As diverse as they are, they share a few common characteristics: an automated online application process, the use of proprietary algorithms to determine creditworthiness, and an emphasis on speed and inclusiveness.
On this point, online lenders have succeeded, according to a study just published by the Federal Reserve Board. According to the Fed’s annual Small Business Credit Survey (SBCS), credit seekers are increasingly turning to online lenders, especially smaller, newer and minority-owned businesses. The SBCS also notes that online lenders are much more likely to fund medium- and high-risk credit applications than their bank counterparts, with approval rates of 76% compared to 34% at large banks and 47% at banks. small banks.
As for what attracts borrowers to non-bank digital lenders, the odds of approval are unsurprisingly high, as the best lenders tend to be the ones that actually grant funds – at least from an SME’s perspective. But speed was an equally critical factor.
This, according to the Fed, is the good news. The most troubling statistics relate to customer satisfaction: SMBs find online lenders easy to work with initially, but they don’t necessarily like what they get from them across the board.
“While more applicants are being successfully funded by online lenders, the SBCS reports that satisfaction levels with online lenders are significantly lower than those with traditional lenders (33% net satisfaction among online lenders). line versus 73% at small banks and 55% at large banks),” the Fed noted in its report. “In 2018, 63% of online loan seekers reported difficulty working with their lenders, with more than half saying they had experienced high interest rates and almost a third raising concerns about unfavorable repayment terms.”
So what’s wrong with the easy application process and living with the loan? According to the Fed, this is actually a more complicated question than it first appears, as the digital lending landscape for SMEs is rather more diverse than for its retail lending counterparts. and businesses. While it’s common to colloquially group all SMB underwriting operations under one “digital lender” umbrella, the study notes, these lenders are very different from one another when delving into the specifics of their setup. .
And those details, the reports note, are quite important. The biggest divide, the Fed notes, is between loans and credit products versus merchant cash advance products. The former typically feature fixed rates, multi-year terms, fixed monthly payments, and APRs ranging from 10% to 80%. The latter involves the sale of future receivables for a fixed dollar amount, repaid with a fixed percentage of the company’s daily sales receipts – and they have terms that vary considerably, although they are generally much shorter, in three to 18 months. interval. The APR equivalents there are much higher, at 80% in the triple digits.
And within those broad categories, the actual specifics vary more widely, the Fed notes, based on other features and functions of a specific online underwriter’s structure.
The first difficulty is that merchant borrowers themselves are often unaware of the degree of nuanced differences that can exist in the realm of online lending, tending to lump all of these very different things under one heading.
“Although some online lenders specialize in specific types of financial products, it is clear from Federal Reserve focus group studies that small business owners view these companies collectively as lenders and their various products as loans. “, writes the report.
The second, and most difficult, difficulty is that simply urging borrowers to do their homework better when researching underwriting options is potentially wasteful – the data they need to make apples-to-apples comparisons are not always readily available. Unlike consumer lending, where the Truth in Lending Act requires underwriters to clearly disclose product costs and features, business lending falls outside the scope of the TIL. This means lenders have much more flexibility in how they disclose their costs and loan structures, down to the language and terms they use to describe them.
And that means even a small business owner who wants to research and understand exactly what they’re getting into can find it complicated.
“Qualitative studies suggest that small business owners have difficulty understanding the wide range of products offered by online lenders and the unfamiliar terminology that some lenders use in their product descriptions,” the Fed report notes.
Areas of particular concern were the borrower’s lack of clarity about the total cost of the loans, lack of understanding of the loan term, and confusion about how the data provided during the pre-application process is collected, stored and possibly used.
Regarding solutions, the Federal Reserve noted that efforts to standardize data reporting among online SME lenders continue, both legislatively in California and through the cooperation of various participants and groups of industry seeking to create a standard before it is imposed on them by legislators. These efforts, however, are complicated by arguments about where the standard should be set when it comes to reporting loan and cost information.
For example, the report notes that while some have argued that the historical APR measure is the clearest and most understandable measure for consumers, some have argued that it should not be applied to small business products with variable payments with no fixed duration, such as MCAs. , because the structure of the product is entirely different from that which was to be measured with the APR.
Additionally, the Fed notes that standardizing cost reporting may not be quite a silver bullet, due to the variety of factors that go into choosing a loan among business owners. .
Research suggests that borrowing decisions are not always cost-driven. For example, while among focus group participants, “best price” was the most frequently mentioned factor in their choice of lender, “a quick and easy loan application process”, “a lender I know and in whom I trust” and “the likelihood that the request will be accepted”. approved” were primary considerations for others.
However, the survey noted that while consumers can make choices about a variety of factors, they must be able to assess them clearly. Cost may not be the determining factor in deciding on a loan product, for example, but all borrowers need to know what the costs will be. And until industry satisfaction levels with the products approximate satisfaction levels for the onboarding process, the Fed data seems to strongly imply that there is still a lot of work to be done. do in terms of presenting SME lending products.