Alt-SME Lenders Go On The Defensive

The alternative finance industry boomed post-2008 financial crisis as banks retreated from small business lending. Marketplace lenders emerged to fill the gap, and analysts began to ponder a paradigm shift: Could alternative lending threaten traditional financial institutions’ place in the world?

Now that the newness of alternative lending has faded, the industry is settling into the market and looking a lot less scary to traditional banks.

Following the explosive, billion-dollar IPOs of OnDeck and Lending Club in late 2014, share prices were nearly halved just months later.

The alternative lending sector is bracing for gentle, yet potentially industry-changing regulation, with the U.S. Treasury Department, the Consumer Financial Protection Bureau, the Federal Reserve and other policymakers having taken recent steps to learn more about these companies ahead of any legislation.

And, in what could be the final nail in the coffin, the Federal Reserve published the results of its study on small businesses’ experience with online lending platforms, concluding widespread dissatisfaction with it all.

Three-quarters of SMEs that secured a bank loan reported satisfaction with the process; just 15 percent of those that nabbed financing from an online marketplace, however, said the same.

High interest rates, unfavorable repayment terms and a lack of transparency were all cited by small business owners as reasons they were disappointed with going the alternative route to find financing, the Fed stated.

Alt-Lenders On The Defense

Clearly, the alternative lending industry did not uproot the bank lending landscape as some had previously predicted.

Instead, marketplace lenders may now be shifting from confidently facing off against the big banks to recalculating their role in the small business lending food chain.

Alt-lenders are doing more than cooperating with federal inquiries and questionnaires about their business practices. Last year, companies, including Funding Circle, Fundera and Lending Club, banned together to develop the Small Business Borrowers’ Bill of Rights, a set of best practices to be followed by the industry.

The rights include transparent pricing, fair treatment from brokers and inclusive credit access. While several alternative lending platforms have signed on to the voluntary code of ethics, the Fed’s findings of nontransparent pricing and high interest rates in the SME alt-lending process could suggest the industry has more work to do in this regard.

Earlier this month, Funding Circle, Prosper and Lending Club launched the Marketplace Lending Association, a trade group the firms said would aim to promote “sound public policy” in the alternative small business lending space.

“It is really important to be in active dialogue with regulators to provide a forum for thoughtful discussion as the industry develops. Specific regulation [for the marketplace lenders] could be a healthy thing,” said Funding Circle U.S. Managing Director and Cofounder Sam Hodges in a statement.

The latest effort to show that market alt-lenders can be reliable, competitive and effective occurred just days later, when the Small Business Finance Association (formerly the North American Merchant Advance Association) announced its own list of best practices.

The initiative repeats much of what predecessors have championed: transparency, responsibility, fairness and security.

The Small Business Finance Principles, as the group calls them, include statements like, “Provide transparent information that allows small businesses to make educated financial decisions” and “Be truthful and fair in dealings with small businesses.”

Too Bright, Too Fast?

Did the star of the alternative small business lending sector burn too bright, too fast? Maybe, maybe not.

Earlier this year, Bibby Financial Services Chief Executive David Postings spoke with Financial Times to warn that the alternative lending sector is a bubble about to burst.

“We are seeing signs of overheating in the small and medium-sized business lending market,” he stated. “Credit terms are stretched, and pricing is down. It has all the hallmarks of what happened to personal credit pre-2007. There will be a crash sooner or later.”

On the other hand, Peer-to-Peer Finance Association Chair Christine Farnish is more certain about the endurance of the industry.

“Not only are we able to fulfill creditworthy small businesses with their funding or invoice financing needs, but we are able to do this much more quickly and efficiently than the traditional players,” she said.

The alternative lending industry is probably here to stay, though not to compete with banks as once assumed. Players have instead been emphasizing the collaborative relationship between alt-lenders and traditional banks, but with increasing efforts to prove they have a space in the market, alternative SME lenders seem to have repositioned themselves on the defensive line.