With new entrants to the business lending environment adding competition — and then pressured by a two-year cash crunch coupled with new forms of lending that have regulators flummoxed — the industry is undergoing a tectonic change in 2022. In many cases, FinTech and others are edging out monolithic banking practices with more flexible and nimble alternatives.
The number and diversity of participants in the business lending market are likely to be larger and more varied than ever, ranging from payments companies to verticalized Software-as-a-Service (SaaS) companies and niche lenders focused on specific customer segments.
Much of this dynamic was revealed by Paycheck Protection Program (PPP) loans. Now that those are gone, some of the players that helped the government disburse PPP funds are remaining focused on the new business of customizing lending products for small- to medium-sized businesses (SMBs).
“There’s just this massive convergence happening between financial services, software and commerce,” Sam Graziano, head of Amount Small Business and previously CEO at Linear Financial Technologies, told PYMNTS’ Karen Webster.
“In the small business space, we’ve been focused on what we call embedded credit, the idea being whether they be marketplaces or payments companies or verticalized [software-as-a-service] companies, these are companies that are either facilitating payment flows, facilitating commerce, or have significant mindshare with small businesses,” Graziano said.
With their first-party data insights, “It results in [non-bank firms] being the optimal places to deliver capital. I think that trend is going to continue with a number of different use cases.”
Harking back to lessons learned during PPP, Graziano said many SMBs didn’t go to their primary bank for working capital because they felt they wouldn’t qualify — which, for many, is true.
Accordingly, “Millions of businesses went elsewhere,” he said.
“They went to loan marketplaces,” Graziano continued. “They went to alternative lenders. They went to Square. They went to Divvy. They went to a bunch of different places to get capital. There was a wake-up call for a lot of small businesses that banks are not the only place you go when you need capital.”
This is where Amount Small Business comes in.
“The volumes we’re seeing coming through online and mobile channels are tremendously higher than they were pre-COVID, which tells you there’s been a paradigm shift,” he said.
The Paradigm Downshift
A paradigm shift to what? Noting that new business formation has been off the charts in recent years, he said the shift refers to the complexities of the small business market and how many more of them are pursuing credit from digital channels, including banks.
Dismissing the idea that big banks don’t lend to small businesses, Graziano said they do, but they generally prefer established ones with good historical credit quality.
“New and young businesses, by and large, are the hardest ones to serve for credit,” he told Webster. “The success rate or failure rate, however you want to define it for small businesses, generally takes five years or so before a small business proves it has staying power.”
He added that trends from gig economy work to the specialized needs of microbusinesses versus SMBS — be they digital, physical or both — shows that businesses seeking credit online instead of at banks have tended to have a very different profile.
“It’s generally less-established businesses that are going through digital channels, which means you need a different lending model if you’re going to serve that customer population,” Graziano said.
Touching on contextual lending, he mentioned Square Capital and Shopify Capital as prime examples of new digital-first lenders that are “relying on nothing other than the data they already have on these customers, so they are extremely well positioned to lend to those customers because they have real time visibility into their sales activity.”
That adds up for Amount Small Business, which is leveraging an existing trend that’s gathering new force.
“Financial services is generally trending toward verticalization and personalization. I think the small business market is in many ways ground zero for that,” Graziano said.
New Adventures in Underwriting
In a world increasingly populated by specialized lending, from different types of buy now, pay later (BNPL) to various forms of trade credit, where do legacy banks fit in?
First things first: Graziano says account opening and other services must shake off the legacy dust and modernize everything from the borrower experience to the underwriting strategies, datasets utilized and back-end processes.
“You have to build lending models that are accommodative to what the market looks like today, but I also think you need to start really focusing on what are those other services I can provide to these customers when they are ‘banking with me,’ when they’re logged into my systems,” he continued.
As banks think about joining the embedded and contextual lending fray, they can borrow strategy from the pure-play BNPLs to absorb some of that digital-first sheen. This solves several problems for banks and financial institutions, from mindshare to payments volume and more.
“[Banks] certainly have many more customers than [BNPL firms],” said Graziano. “If you can start to almost disintermediate those other platforms, the competitive landscape becomes even more fair.”
How will big banks get there? Don’t rule out mergers and acquisitions.
Graziano told Webster, “I think you’re going to see banks start to buy more FinTechs. We are past the point of ‘is this FinTech thing real?’ Now, I think we’re at a point where a traditional financial services player can buy a FinTech affordably and make it make sense both strategically and financially.
“If that is the case, I think you’re going to see a lot more acquisition activity happen.”