How COVID-19 has changed business lending in 2021
Embedded financing and a de-emphasis on credit scores look like they’re here to stay.
COVID-19 has made fundamental changes to the way lenders fund small businesses. And after attending industry conference LendIt Fintech USA 2021, it appears that some of those changes are here to stay.
The unprecedented demand for Paycheck Protection Program (PPP) funding forced banks and fintech companies to partner in 2020 — meaning it’s a lot easier to get a business loan from a bank online than it was before. And government agencies like the Small Business Administration (SBA) were also forced to recognize, and therefore give legitimacy to, online lenders, which has led to a rise in bank charter applications from online lenders like SoFi.
Credit scores, which take as long as six months to reflect a change, also became obsolete overnight and lenders were forced to shift their underwriting process to focus on other factors like cash flow. Protests that erupted over the summer of 2020 also forced business financing providers to shift focus toward the social impact of their lending practices.
These shifts were stop-gap measures at first. But as the economy starts to open up to small businesses, here’s what small business owners need to known before taking out a loan in 2021.
It’s a borrower’s market — but that might not help you get approved
Between the PPP, the Restaurant Revitalization Funds and other government programs, the demand for business loans is down. Lending is down about 4% year over year, according to the Experian Senior Vice President of Global Analytics and Artificial Intelligence (AI) Products Srikanth Geedipalli — meaning lenders are competing to serve fewer borrowers. And that’s expected to last for a while.
“The credit appetite will likely be low over the next 12 months,” said Geedipalli, speaking during a round table discussion on credit models during uncertain times.
But this is not a normal borrower’s market. Lenders tightened their credit standards or stopped offering financing altogether during the first few months of the coronavirus outbreak in the US. And while many started loosening requirements over the past year, it’s still harder to qualify for a business loan than before.
This could mean lenders have ramped up their marketing strategies to serve businesses they know are a sure thing. But startups and industries that are struggling might have an even more difficult time qualifying.
Lenders are offering more than just financing
Many lenders paused their programs to offer PPP loans and launch other products during COVID-19. But it looks like one-stop-shop financial services here is here to stay.
“Having a good core banking experience is not going to be enough in the future,” Senior Vice President and Enterprise Consumer Experience Insights at Wells Fargo Menekse Gencer said during a panel on lending in the post-pandemic world.
This is partly because small business owners just don’t have as much time to adjust to a new market and shop around for financing. But it’s also partly because it gives them access to more real-time data that’s more accurate than just looking at a credit score — which can be unreliable in a quickly changing economy.
Some lenders are starting with small businesses. Online lender Kabbage, for example, launched a business checking account for small business owners in July 2020. Peer-to-peer platform Fundbox has started partnering with companies that offer merchant services to meet small business owners’ customers where they are — often referred to as “embedded financing.”
But platforms like Intuit and Shopify have a more holistic approach. Using data they already have from current customers to underwrite loans, they offer financing directly through to users.
“The way we think about things at Shopify is how do we help remove the barriers to entrepreneurship,” said Shoppify Vice President of Merchant Services, Kaz Nejatian during a panel on embedded finance. “We try not to think of them in terms of financial and non-financial solutions, but in terms of what’s getting in the way of their business.”
Not only does this require a shorter application and less paperwork, it also makes it easier for the smallest businesses to get approved based on their financial track record instead of their credit score and time in business. And they’ll see their money faster.
Underserved populations could have an easier time accessing credit
Fintechs and online lenders have always touted their use of “alternative data” — like spending or shipping records — as a way to finance businesses shut out of the credit system that heavily relies on credit scores. But this year, financial fairness was front and center of some lender’s plans for the coming years.
“There’s more companies focusing on the underserved than ever before,” LendIt Cofounder Peter Renton said during the conference’s opening remarks. In fact, the industry has seen a 25% increase of interest in creating a fairer financial system over the past year, according to Renton.
It’s possible online lender Camnio Finance made the most radical shift in this direction: it became the first online lender to become a certified Community Financial Development Institution (CDFI) in April.
CDFIs are nonprofit lenders with a mission to offer services that develop the economies of specific communities. Usually they serve one small geographic area, but Camino is different. It’s one of the first CDFIs with a national reach. Because it isn’t geographically limited, its focus is on underserved businesses, with an emphasis on the Latinx business community.
Your lender might need to meet higher standards in the near future
Part of the focus on fairness is in response to social and racial justice protests last summer. But lenders are also expecting more regulation relating to fair financial practices from the Biden administration.
“I think we’re gearing up to be in an era that’s much more aggressive in terms of regulation than the Obama era,” Jonice Gray-Tucker, a partner at Buckly LLP said during a panel on President Biden’s financial appointees.
Gray-Tucker predicts that this might slow innovation. But it could also help ensure that your online lender has to meet higher standards than the relatively unregulated industry faces. And it could force lenders to prove that their artificial intelligence technology doesn’t have built-in biases — a common criticism of the tech industry.
What it means going forward
Like remote work, the rise in online lending doesn’t appear to be dying down any time soon, even with a new administration eyeing tighter regulations for business lenders.
You might not even have to go to a lender to find financing. And business owners from communities traditionally shut out of financing might have access to more financing. But before you decide on a lender, compare all of your options to make sure your ecommerce platform, accounting software or CDFI actually offers a good deal.