Main Street small and medium businesses (SMBs) are still struggling with cashflow issues as the pandemic wanes, but they’ve come to rely on the new breed of FinTech lenders to get them through the worst of it.
In the April 2022 working paper “The Impact of Fintech Lending on Credit Access for U.S. Small Businesses” published by the Federal Reserve Bank of Philadelphia, an analysis shows that alternative lenders are proving more responsive to SMBs than traditional banks in many ways.
FinTech lenders’ strength is their ability to “to digitally collect and analyze nontraditional data, including what used to be referred to as soft information in relationship lending. This allows them to capture a more complete financial picture of the borrowers than traditional lenders can.”
PYMNTS data underscores the urgency that Main Street SMBs are now facing.
In the study The Main Street Economic Health Survey: Navigating Economic Uncertainty, a PYMNTS and Melio collaboration, a survey of over 500 U.S. SMBs, we found that while “cash cushions improved for some firms, the portion of businesses with no available cash rose to 18% from 15%,” in Q1, showing the cash pressures that recovering SMBs are still under.
Underscoring the issue, the Main Street Economic Health Survey noted that “25% of Main Street businesses that sell mostly through physical locations have no available liquidity — nearly double the portion of firms with no liquidity that conduct most of their business online.”
The Alternate Credit File
With traditional credit tight in a volatile and inflationary economy coming on the heels of two-year global health emergency, Main Street businesses are looking beyond their primary banks for the cash needed to invest in digital solutions and make their operations more resilient.
The Philadelphia Fed’s report notes several ways that nontraditional lenders used different data — or used data differently — to lend to SMBs lacking the bona fides big banks typically require, but who have established a solid history with payments platforms offering SMB financing.
According to that report, “Several big-tech payment platforms, such as Amazon, and FinTech payment firms, such as Square and PayPal, have also lent to business owners who may have thin credit files, but whose cash flows and payment transactions have been established through their payment platform.”
Liquidity and Risk
Comparing microdata from small business lending (SBL) platforms Funding Circle and LendingClub, together with traditional credit card data analyzed monthly by the Fed, the report concluded that FinTechs are filling a vital gap — and competing more with traditional lenders.
“FinTech lenders can serve borrowers who were less likely to receive credit from traditional banks [because] they employ alternative data to improve credit scoring,” it states.
The working paper added that “FinTech platforms’ internal credit scores were able to predict future loan performance more accurately than the traditional approach to credit scoring,” adding, “We confirm that FinTech lenders provide credit to additional borrowers at lower cost.”
It’s clear both from the Philadelphia Fed’s analysis and PYMNTS data that alternate sources of business financing are helping thin-file businesses and SMBs in underserved “credit deserts” address cashflow, and many remain underfunded as a new year steams ahead.
To illustrate, PYMNTS’ Main Street Economic Health Survey found that 31% of personal and consumer services firms had no cash reserves in Q1, as did 29% of retail establishments, 11% of food, entertainment and accommodations businesses, “and 10% of both the professional services firms and the construction and utilities businesses surveyed.”
There are doubts, however, as The Fed and other agencies examine the impact of new credit models like buy now, pay later (BNPL), as well as the premiums FinTechs charge for SMB loans.
The working paper notes there are “concerns about the potential impact of these disruptive business models on consumers, business owners and financial stability, especially if the FinTech credit scoring techniques do not prove to be valid in a different stage of the economic or financial cycle (such as a deep recession).”