How Technology Changed the Lending Industry
The online lending industry has been growing over the last couple of years at an incredible pace. Whether for business or personal, more loans are originated online than ever before. The industry was basically born out of the financial crisis. At the time banks were subjected to tougher regulations. To make matters worse for those seeking credit, the poor economic environment made banks strongly averse to risk. As a result loans in any form became scarce. As the demand grew online lenders stepped in to fill the gap. Although the industry started on the backs of tougher banking regulations and the need for banks to avoid risk, it was actually technology and innovation that was the main contributor to the boom in online lending. If the growth trajectory continues there is good reason to believe that online lenders will replace banks as the go-to source for both business loans and personal loans.
Many of the statistics are hard to track in the online lending space because a large portion of the companies are small and private, however, there has been some recent statistics reported by a handful of companies in the public spotlight. According to a report by the California Office of Business Oversight, “Thirteen of the online lending sector’s largest firms made $15.91 billion in U.S. loans in 2014, up 700% from 2010… In the first six months of last year , the same firms extended $12.47 billion in credit nationwide”.
These numbers represent only a handful of lenders in the industry but it provides insight into the type of growth being realized in the sector. It is important to highlight that online lending consists of both commercial lending as well as personal lending. As for the overall distribution of online loans “Consumer lending accounted for 82% of the total loan volume in 2014 at the companies surveyed, and small-business financing accounted for the remaining 18%”. Based on these statistics there is good reason to believe that online lenders are providing capital to potential banking customers.
How the Online Lending Industry Began
The main reason for the start of the online lending market is that borrowers needed money and banks were not providing that money. There is a wealth of data to show that U.S. banks had tightened lending to both companies and consumers at the start of 2008, and that trend would continue on for several years. In fact, there is good reason to believe that banks are still not lending to many potential customers. As a result of the financial decisions made by bank officers and institutions over the years, the demand for capital from sources other than banks was established and online lenders continue to take advantage of it.
How the Online Lending Industry Grew
Many consider online lending as the future of bank lending. The reason for this shift is not because of an absence of lending by traditional banks, that only helped open the door to alternative lending options. It is actually the innovation through technology and the resulting overhaul of the entire loan process by online lenders that has made the industry grow to where it is today. The main problem with the traditional bank loan process was that it was archaic in a society that was becoming more modern. Instant gratification, quick responses, short wait times and minimal personal interactions are now expected. As Bill gates stated in 1994, banks are “Dinosaurs”, and this statement is even more relevant today in regards to lending money.
The Innovation in Online Lending
Online lenders used technology to innovate the lending industry like Amazon did to books and retail. The innovations started with the application a borrower completed and solved issues throughout the entire funding process. The first problem solved for today’s borrower was that you no longer need to visit a bank to get capital, all you need is a smartphone or laptop. The traditional bank loan application required the borrower to physically be in the bank, and most likely follow with several more visits just to get the application started. Today for so many reasons people want to borrow through an end device that allows them to continue with their daily business.
People today are extremely busy in their everyday lives, there is simply not enough time in the day to go to the bank if it can be avoided. More and more the modern consumer is resorting to online transactions in place of visiting a location to make a purchase or get something done. A great example of the transition to online transactions is found in the travel industry. For years big ticket items such as hotels and airline tickets were purchased by visiting your travel agent and sitting down in an office. With the growth in online travel sites such as Priceline and Travelocity it is easy to see that people no longer want or need the “in office” experience. This idea is further supported by the growth in ecommerce, online insurance policies and mortgages, virtual meetings, and all the government offices no longer visited because so many transactions are now conducted online.
Another killer to the bank loan application process was the actual amount of time required to complete the paperwork. According to the statistics at three conventional banks the amount of time small business owners spent on the completion of paperwork was on average 25 hours, the online lender’s entire application could be completed in 30 minutes, and it can be done from a handheld device. This type of speed helped establish a clear competitive advantage for online lenders.
The speed of the application process is also important is because borrowers want to know if they are approved and for how much. Decisions in life and business today need to be made in nano seconds, it is the difference between success and failure. Traditional bank lending could leave a borrower waiting for months to get an approval whereas a borrower can have an answer in a matter of hours with an online lender.
It is not only the speed of the application process that made online borrowing more attractive than traditional bank loans, it is also the speed in which a borrower could actually have cash in hand. One of the earliest selling points of online lending was approvals within 24 hours, cash in your account in 2 to 3 days. The stark differences between the application processes are night and day, and in a fast pace society where time means everything, more and more people are going online for their funding. Technology has clearly helped innovate the application process, but online lenders did not stop innovating with the paperwork, they are also using it for the underwriting process as well.
Technology has played a fundamental role in the underwriting process for online lenders as of late. Whereas banks have always relied on personal credit or FICO scores as a main approval factor, online lenders incorporate hundreds of factors to approve a loan with FICO being just one small part. Predictive modeling and the aggregation of data is how online lenders determine a borrowers probability of paying back a loan.
The bank loan underwriting process is outdated in a much more complex society and it does not reveal the true probability of whether a borrower can pay back a loan or not. A great example of this in a recent article highlights the point when considering a small business loan for a company. “Where a bank sees a generic SMB with a business owner FICO score of 650, OnDeck [an online lender] sees a plumber with far higher efficiency than comparable businesses in its zip code”. Lenders also incorporate background checks, online reviews, social media and a variety of other indicators to determine the health of a business. Some even incorporate a company’s Quick Books entries and various other cash flow statistics to underwrite a loan. All of the data available on a borrower can be aggregated in a matter of hours because of the advancements in technology. Having data so quickly and a technologically advanced understanding of that data is what allows online lenders to approve personal loans with FICO scores under 700 as well as approving bad credit business loans for small business owners with FICO scores under 600. Technological advancements and continuous innovation allow online lenders to continue to analyze prospective borrowers and approve loans in an efficient and accurate way.
Advancements in technology and a completely overhauled traditional lending process is likely the reason for the success of online lending. The industry continues to grow exponentially and the more accurate and technologically advanced the funding process becomes the more likely online lending will become the place to acquire a loan in the future.
Sam is an expert in small business financing and has been CEO at Shield Funding for more than a decade. The company has funded more than 1000 small businesses and has been a significant contributor to the phenomenal growth that many of those companies have experienced.