Small businesses are turning to online lenders much more often: Fed

Small business owners are turning to online lenders for financing far more frequently than they did even two years ago, the Federal Reserve Banks have found in a new survey.

Last year, 32% of small businesses seeking credit used an online lender, up from 19% in 2016, according to the survey released on Tuesday. During the same period, large banks, small banks and credit unions all saw stable application rates or a slight decline in interest from these same small businesses, which typically had fewer than 10 employees.

These business owners rely more on online lenders, although they ultimately tend to be relatively dissatisfied with their choice, according to the survey. Respondents cited high interest rates in the online lending industry as a major source of dissatisfaction. Annual percentage rates in the online business loan industry often exceed 25% and can be much higher.

Still, the results suggest that more traditional lenders risk being left behind if they don’t match the faster processes offered by many online lenders. Among small business owners who applied to an online lender, the top reason given was how quickly they expected to receive either a loan decision or the requested financing.

“We can tell from the factors they cite in their choice of lender that they value speed well above cost and interest rate,” said a Fed researcher who worked on a report summarizing the results of the investigation during a call with reporters. The meeting with the researchers was granted on the condition that they were not mentioned by name.

In contrast, speed was not among the top three factors cited by business owners who applied to large banks or small banks.

The survey, conducted in the third and fourth quarters of 2018, yielded 6,614 responses from all 50 states and the District of Columbia. Respondents covered a wide range of industries.

Nearly three in four businesses had fewer than 10 employees, while 71% reported annual revenue of $1 million or less.

In their sales pitches, online commercial lenders often emphasize their quick decision-making. “Business financing in as little as 10 minutes,” proclaims the website of 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 longer than a month to receive the funds. In response to the lack of customer experience, some banks have taken aggressive steps in recent years to offer a digital application process that matches what online lenders offer.

In the Fed survey, respondents who were medium or high credit risk said they were much more likely to go to an online lender than those who were low risk. Many loan seekers have cited their expectations of their chances of being approved as one of the main reasons they choose an online lender.

And potential borrowers are right to assume that they are more likely to be approved by an online lender. The approval rate for online lenders was 82%, compared to 71% at small banks and 58% at large banks, according to the survey.

The Fed data also suggests online commercial lenders have eased their lending standards, as their approval rate rose 13 percentage points in two years.

“What we’re seeing over time is really what I would call a triage of potential borrowers,” a second Fed researcher said on the call Tuesday.

“We’re essentially seeing companies with lower credit risk moving into very conventional channels, and lower risk channels, those that may have a longer hold time, but offer better rates.”

The survey also contained new findings on the relative popularity of different types of online business lenders. Among small business owners who applied to an online lender, 66% said they chose a direct lender such as Kabbage or OnDeck Capital.

Companies such as PayPal and Square, which offer financing to businesses using their payment processing services, have proven less popular. Some 17% of business owners who applied to an online lender said they chose a payment processor.

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