What banks can learn from what business borrowers dislike about online lenders

As bankers know, online and “alternative” lenders are a small but growing group of players in the business lending market.

Small business loans represented about $7.4 billion of originations from alternative lenders in 2016, according to data from Morgan Stanley’s Alternative Lending Group and the Cambridge Centre for Alternative Finance. That’s up from an earlier Morgan Stanley estimate of $4.6 billion in 2014 issuance. Meanwhile, loans to small businesses by banks with assets below $10 billion declined 2 percent to $269 billion in 2016, according to a 2017 survey by the Federal Reserve and the Conference of State Bank Supervisors.

Despite the lopsided market shares, banks aren’t ignoring these competitors. A recent report on how “Mom & Pop” small business borrowers view online lenders provides some interesting perspectives – not only about what borrowers like about them, but also about what they dislike about online lenders. Savvy financial institutions may be able to strengthen their position as the go-to source for funding among small businesses by reviewing findings of the report by the Federal Reserve.

The report, “Browsing to Borrow: ‘Mom & Pop’ Small Business Perspectives on Online Lenders,” is based on a small, focus-group based study designed to gather insights for future research. It included small businesses with 1 to 20 employees, in business at least two years and with revenue of between $200,000 and $2 million. Each of the businesses had sought credit within the previous year.

One of the findings? Banks are still the go-to credit source.

“With respect to where they would turn for funding, participants overwhelmingly prefer traditional financial institutions to online lenders, personal connections, or using their credit cards,” the study said. “As one participant put it, ‘I would most likely try a traditional bank first. I’m looking for credibility and reliance. Then I’d look online just to see my options.’”

A typical response among those likely to consider an online lender, on the other hand, was that online lenders are more flexible with their approval process. Even participants who had recently applied at banks, and were generally pleased with their product terms and interest rates, expressed concerns about the time-consuming paperwork, long wait times for approval and actual funding and stringent borrower qualifications at traditional financial institutions.

Complaints about online lenders

As for what business borrowers disliked about online lenders, most complaints had to do with unforeseen fees or costs, frequent or high payments and over-communication, even if the borrowers liked the less complicated process. Only about one-quarter of the participants had actually submitted a full or partial application to an online lender. But most study participants, even those who had never applied to online lenders, reported receiving annoying emails or mail from the lenders, and they named that as being one of the negatives of online lenders.

Participants who were asked to visit a few online lender websites and browse as if they were shopping for a $50,000 loan noted a number of turnoffs about those websites. For example, some websites provided little or no information on product terms, interest rates or overall costs unless the website visitor provided information about the business such as an email or contact information. This made it difficult for the visitor to learn about products and compare products without feeling like they would be contacted by a salesperson. The lack of transparency and disclosure undermined website visitors’ trust, and that’s critical, because when participants were asked to rank in order of importance the factors they consider in making decisions about where to go for business credit, they listed “best price” first, followed by “a lender I know and trust.” The factors “likelihood application will be approved” and “quick/easy application process” were also important to participants.

Banks can reinforce the trust they already have with established customers by providing clear information on their websites about the types of financing available to businesses, along with terms, interest rates, costs and qualification requirements so that business owners spend less time researching and applying for loans that might get rejected.

Financial institutions can also use technology, such as an online loan application, to improve the customer experience. Study participants who had used online lenders remarked favorably on the application process, convenience and speed of funding. Small business owners have little spare time to wade through lengthy paper applications and photocopy tax returns, and many of them are unable to take time during traditional bank business hours to visit a branch, which is what makes the alternative lenders’ easy application process appealing.

At the same time, increasing automation of the loan underwriting and decisioning processes can help community banks make sound credit decisions while more quickly servicing important customers, even if those customers are seeking relatively small-dollar loans. When the average bank loan takes weeks to process compared with days for an online lender, speeding up the underwriting process through automation can go a long way toward removing one of the few competitive advantages borrowers see in online lenders.

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