While most experts can agree that the rise in alternative lending has provided entrepreneurs and small business owners with otherwise difficult-to-reach working capital, critics have been turning the volume up on their calls for increased regulatory scrutiny of the market. Marketplace lenders and new forms of small business investing are too young and not regulated enough to be safe for both borrowers and lenders, they argue.
But a new report from DealIndex suggests that the alternative finance boom has actually made finance more transparent, efficient and democratic for borrowers and lenders alike.
Released only weeks ago, DealIndex’s “Democratizing Finance: Alternative Finance Demystified” report examines the interconnected community of alternative finance players, with a focus on crowdfunding in its first volume.
The term “alternative finance,” researchers at DealIndex found, encompasses an array of characteristics and definitions, from a tendency to embrace technology and Big Data, to the ability to expand the boundaries of the traditional investor. But analysts also found something that some may find unexpected: Alternative finance has boosted transparency for entrepreneurs, SME borrowers and lenders.
“Alternative finance has already demonstrated its potential to change the way fundraising is carried out by private companies by implementing a much more democratic, transparent and efficient process for both entrepreneurs and investors,” the report found.
“From a general perspective the digital finance market is all about better access, transparency and efficiency,” said DealIndex Co-founder and Chairman Valto Loikkanen. “This, together with the data that this digital market generates, leads to even faster learning and further development of all areas it spreads to.”
This increased transparency stems from the ability to remove barriers to financial information, DealIndex said, thanks in part to players’ use of high-quality data to fill in the information gaps. “As the private investment market moves online, the ability to harvest large quantities of data surrounding investment decisions becomes easier,” the report said. “Furthermore, tools that allow investors to then analyze the data, uncovering trends, are enabling more informed decisions.”
It’s a trend analysts described as a “radical change” for the traditionally guarded private investment sector, and one researchers said is largely fueled by millennials who are eager for increased involvement in the alt-lending process. As lending innovators establish their operations online, information can more easily be found through these platforms, while a digital space also makes it easier for players to communicate with one another.
DealIndex analysts’ view that alternative finance is an inherently transparent industry may raise some eyebrows, especially to industry experts who say regulators must take a harsher stance in the market to protect investors and small business borrowers.
According to Brayden McCarthy, who heads policy and advocacy for loan comparison platform Fundera, without regulation, alternative lending is “effectively the Wild West in the small-business space.”
“It is shocking the number of borrowers that don’t realize their persona assets are at stake,” he said in a May 2015 interview with American Banker.
The report highlighted claims from the U.S. Treasury Department that the industry needs to increase its transparency so regulators can properly create the rules. “More data is needed to fully understand how these lenders and their products compare to traditional banking products for small businesses,” said Treasury spokesperson Dan Cruz in the American Banker report.
DealIndex does not dismiss the concerns of critics who are calling for increased regulation on the industry. “With rapid growth in the alternative finance space,” the report concluded, “comes the need for increased maturity in the industry and systems to content with the unknown and untested impact of changing credit and interest rate cycles, liquidity squeezes, fluctuating asset pricing and valuations, and the impact of the macro economic environment.”
Plus, analysts said, rising funding rounds and shortening funding cycles, among other effects of alternative lending, create “the need for best practices to be applied from financial services.”
But according to Loikkanen, the steps regulators will begin to take can either make or break the ability for alternative finance to provide transparent financial services.
“Governments play a very important role in digital investing markets,” Loikkanen said. “Anyone who innovates spends significant effort on doing their own risk assessment and due diligence. While it’s understandable that laws and regulations typically follow innovation, the most important factors for risk assessment are the easy availability of information and the clarity of the regulatory environment.”
In other words, regulation impacting alternative finance should be just as focused on transparency as the alternative finance market itself is. Otherwise, DealIndex found, lawmakers will risk extinguishing alt-lending’s innovative flame.
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