The Chatter About Alternative Lending Can Be Overwhelming. Are You Up to Speed?

What follows is the first of what I expect will be four posts on alternative lending. This post covers the basics: What exactly do people mean when they talk about alternative lending?

In future posts, I plan to cover the ways banks and credit unions are addressing the rise of alternative lending, where the opportunities lie for these institutions, and how technology comes into play in this developing field.

After reading this, if it sparks a question or if you strongly agree or disagree, please feel free to start a discussion on Twitter or LinkedIn Groups such as Credit Union Insight, Credit Union Times, Community Bank Insight or Bank Innovation. 

The Standard Characteristics of Alternative Lenders

In general, when people refer to alternative lending, they are talking about online-only businesses that claim to make borrowing easier for consumers and small businesses than banks and credit unions do. To get more specific, these lenders usually share these six traits:

• They evaluate borrowers in new and different ways. As Karen Mills, a former administrator of the Small Business Administration and current senior fellow with the Harvard Business School, wrote in Fortune in April, "They use new algorithms to access and analyze more data from different sources about a borrower than the traditional bank."
• They make loans with "aggressive terms." The Wall Street Journal reported last year that alternative lenders' APRs generally ranged between 12 and 25 percent.
• They face little regulation, despite calls for increased scrutiny on Capitol Hill and elsewhere.
• They offer a better user experience, with better online tools, less paperwork and a faster turnaround than most banks and credit unions offer. Noah Breslow, the CEO of alternative lender OnDeck, told Inc. in 2014 that his company "can approve a loan in minutes using 2,000-plus data points per online application."
• They offer applicants greater transparency into the process – as Biz2Credit CEO Rohit Arora told Bankless Times in June, "Traditional lenders approve or reject but do not give reasons for their decision. Every customer should get insight into their credit worthiness so they can see what they can do to improve it."
• They approve more loans than traditional lenders do – reasons include alternative lenders' lower fixed costs (they're not maintaining branches and running mainframe computer systems, for instance), their openness to innovation and the aforementioned lack of regulation. (However, it should be noted that traditional lenders have started approving more loans in recent months, while alternative lenders seem to be lowering their approval rates. Read more in this Bankless Times piece from June.)

The Size of the Alternative Lending Market

Some key stats help gauge the scope of this growing industry segment:

• In the spring of 2014, Inc. magazine identified more than 100 alternative lenders operating in the U.S.
• Mills's Fortune piece cited the growth of LendIt, an alternative lending industry gathering. The conference didn't exist four years ago, but had 700 attendees in 2014 and then more than 2,500 in 2015. "What was clear," Mills wrote, "is that it's no longer a question of whether these disruptors will change the game in small business lending, but how quickly."
• In June, Business Insider reported, "It's still early days for alternative lending; P2P lending companies in the US originated $6.6 billion in loans [in 2014], however, the total value of revolving US consumer debit was about $800 billion."
• In March, a TechCrunch article estimated that the market could grow to $1 trillion.

The Three Segments of Alternative Lending

In a Harvard Business School paper Mills published in 2014, The State of Small Business Lending (pdf), she identified three distinct types of alternative lenders:

• Lenders who use their own balance sheet to fund loans. "They are raising capital from institutional investors, including hedge funds, and using proprietary risk scoring models that include non-traditional data to decision loans for small business owners." Examples: OnDeck and Kabbage.
• "Peer to peer" lenders. They serve as middlemen who help both prime and sub-prime borrowers get funds from institutional and retail investors. Examples: Lending Club, Prosper and Funding Circle.
• Lender-agnostic marketplaces. As Mills writes, they "connect borrowers with a range of traditional and alternative lenders" online. Examples: Fundera and Biz2Credit.

The facts and figures above paint the picture of a vibrant and growing industry. In future posts, I'll aim to explain what that means for banks and credit unions. 

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