August 23, 2018
When people think of alternative lending, the things that unnerve them are the unsecured loans that are to be paid back on paydays or the ones procured from loan sharks that hound their customers like a pack of ravenous wolves. But for the millennial, the alternative lender looks like a friendly orca that rides the online waves. Today, alternative lending is all about commerce – not credit. They have evolved with changing times to deliver connected digital experiences with aplomb.
Alternate lending is the broad spectrum of loans offered to SMBs and consumers, which is beyond the scope of a traditional bank loan. This enables businesses to satiate customized financing needs moving their rudder against the wave of a conventional bank loan’s monopoly.
Alternative lending is gaining considerable traction in the e-commerce segment, with the focus on smaller retail players. The smaller businesses strive to find affordable funding solutions to keep their business up and running. Alternative lenders are a welcome respite from the traditional players with smaller approval cycles and retailer-friendly criteria, provided the lenders verify a seamless flow of revenue. For instance, PayPal offers working capital loans to small businesses that transact more than $20,000 within 12 months.
There is a huge, untapped treasure trove of a market, casting inviting glances at these startups. Besides, it also provides the necessary traction for VCs to join the party and devour the lion’s share of profits by generously funding such startups. Among all FinTech segments, lending led the funding race in June 2018 with ~$790 million in funding across 31 deals. This was a staggering 230% MoM growth in the funding in this space compared to May 2018. The burgeoning IPO listings to raise share capital are also growth indicators of the industry. GreenSky, for instance, has raised share capital to increase its market value to $4.35 billion.
The dawn of the digital era is witness to a spurt of alternative lenders who have created innovative digital products using disruptive technologies for a chartered roadmap to development. The total amount of loans disbursed by FinTech based lending companies was a whopping $28 billion in 2015.
There are quantifiable numbers which drive evidence to the rise of the alternative lending industry. Australia has seen an outburst of disruptive proportions, with a market value of $610 million, to rise as the second largest market in the region. This is followed by China, which leads the APAC region. Besides, a MEDICI report suggests that VC funding for alternative lending startups has found growth from $26.64 million in 2010 to a massive $1.56 billion in 2017. We can imagine the growth of such alternative lenders today!
They have also come up with interesting low-risk business models which also double up as low-interest initiatives for the lendees involved. Payability, for instance, awards loans for Amazon’s retail sellers based on their future payouts. BravoCapital follows the same model for application developers who work for Apple.
The alternative lenders have left no stone unturned in their quest for an unparalleled customer experience. Clearbanc, for example, leverages analytics to provide interest-free cash advances for retailers. Based on a six-month historical data from Airbnb and Shopify accounts, they validate the health of a business to award the loan. Their only charge is a fixed flat fee with no strings attached. Now that’s a good bang for the buck.
Retailers are notoriously poor at bookkeeping. They also have archaic and legacy systems which do not help the cause. Businesses in the US and the UK could be missing out on an economy worth as much as $140 billion due to their disconnected data roadmaps.
Asymmetric information and disparity in data management systems dement transactions and become sources of vanity metrics. But the digital historical data needs no such validation. There are verifiable third-party and FICO data which seamlessly map payback risk, something that the retailer can never meddle with. CapitalFloat, for example, offers merchant cash advances based on card transaction trails and consistent card settlements. LendingKart also provides transaction-based loans which negate the need for collaterals or net worth details. They push it up a notch for the e-commerce vendors, with requirements as simple as bank e-statements.
This is also a workable business model for B2C customers. Here the collateral is earned, unpaid days of work. It’s a clear win-win as the lender knows it can be paid back as it originates from the paycheck. Since there is a low risk, the fee is affordable – a penny compared to the debt trap of payday loans. Earnin, Instant Financial, PayActiv, DailyPay, and FlexWage are a few examples of businesses who offer this initiative.
This has even attracted attention from bigwigs like Walmart. They have partnered up with the personal finance app Even to offer a similar benefit to its employees called Instapay. Besides implementing it within their system, they are offering it as an enticing option to lure human resource.
The definitive ingredient in the reduction of loan payback risk is the ultimate credit counterparty, which in this case, is the company.
A payroll deduction loan works well because of the guaranteed payment coming directly from the company. Otherwise, the interest would rise to infinite proportions, thanks once again to the inherent risk involved.
The payroll deduction loans do precipitate a few challenges though, like employee termination, death, mergers & acquisitions, employee relocation, change of employee payroll to an entity company, etc. Laws are abstract to different challenges like voluntary retirement, cease & desist, Chapter 11, Chapter 13, and Chapter 7, i.e., company bankruptcy and individual bankruptcy. But these challenges are more of exceptions and the above analysis clearly states that the benefits outweigh the challenges, hence making it a viable business model.
While credit scores used to be accurate and quite a few large companies have been able to leverage positive default rate numbers by generating their own custom scoring frameworks, it is still no match to the above data-driven factors. The former is more vulnerable and less accurate these days as it can no longer thrive in a dynamic environment that is constantly posed with various risks, issues, and millennial expectations. Hence, data-driven factors have evolved with time to be more accurate and egalitarian than the linear approach of a credit score.
A better perspective to alternative lending could be lenders driven by disruptive technologies and FinTech. Unlike traditional institutions that often employ antiquated legacy systems, online lenders build their models on advanced technologies for more accurate creditworthiness assessments. They are able to make loan decisions much faster, significantly improving applicants’ experience. They implement automation for repetitive tasks like approval processing and underwriting to prevent rigor mortis, besides saving valuable human resources.
Our perception of alternative lending and what products can and should be delivered by them are changing rapidly – we are in for many more surprises in the years to come. They bring in ingredients of money, mix it with recipes of low risk, pour it in the cauldron of technology, flavor it with affordability, and ice it with an unmatched UX/UI brought about by FinTech.