Fed study provides insights on small business applicants to online alternative lenders

Nonbank online lenders, also referred to as online alternative lenders, represent a small, but growing source of financing for small businesses across the US. How do small businesses that are seeking credit from online alternative lenders compare to small businesses that are applying only to traditional financial institutions, such as banks and credit unions? And in what ways do their experiences with lenders differ?

To explore these questions, Barbara Lipman, an analyst at the Federal Reserve Board of Governors, and Ann Marie Wiersch and Brett Barkley, analysts at the Federal Reserve Bank of Cleveland, examined data in the Fed’s 2015 Small Business Credit Survey. Among their findings:

• Small businesses using online alternative lenders tend to be smaller, younger, and less profitable than firms using traditional lenders, and they are more likely to be minority-owned.
• Firms that sought credit from online lenders reported lower overall approval rates, despite the perception among many small-business owners that they have a greater chance of being funded by an online lender.
• Successful applicants reported lower levels of satisfaction with their online alternative lenders, citing in particular concerns with high interest rates and repayment terms.
• A low credit score was the top-reported reason online lender applicants were denied credit.
• Credit denial was more likely to result in difficulty meeting expenses for online lender applicants. Both groups reported that financing shortfalls would delay plans for expansion of their businesses.

In their report, Wiersch, Lipman, and Barkley also note some concerns that they say merit further investigation:

• Applicants to online alternative lenders are more likely than traditional applicants to report multiple reasons for borrowing, simultaneously citing operating expenses, refinancing debt, and funding expansion of their business. “For a subset of the applicants, these multiple financing needs may indicate that their businesses are financially precarious,” say the authors.
• Banks and other lenders are a common source of financial advice for the vast majority of traditional lender applicants as well as for more than two-thirds of online applicants. However, a loan broker was cited by nearly half of online applicants as their second major source of financial information. “Brokers often compete actively to deliver clients to online alternative lenders, and can obtain substantial upfront referral fees,” say the authors. “Recent research suggests that the majority of small business borrowers do not comparison-shop online when applying for a loan, so they may not be ending up with the most appropriate and affordable product.”

Online alternative lenders use data-driven processes and technology for underwriting, pricing, servicing, and delivering funds to borrowers. They offer various small-dollar credit products to small business customers such as short- and fixed-term loans, lines of credit, and merchant cash advances.

For the complete report (pdf), see Click, Submit: New Insights on Online Lender Applicants from the Small Business Credit Survey.

Federal Reserve Bank of Cleveland

The Federal Reserve Bank of Cleveland is one of 12 regional Reserve Banks that along with the Board of Governors in Washington DC comprise the Federal Reserve System. Part of the US central bank, the Cleveland Fed participates in the formulation of our nation’s monetary policy, supervises banking organizations, provides payment and other services to financial institutions and to the US Treasury, and performs many activities that support Federal Reserve operations System-wide. In addition, the Bank supports the well-being of communities across the Fourth Federal Reserve District through a wide array of research, outreach, and educational activities.

The Cleveland Fed, with branches in Cincinnati and Pittsburgh, serves an area that comprises Ohio, western Pennsylvania, eastern Kentucky, and the northern panhandle of West Virginia.

Media contact

Doug Campbell, doug.campbell@clev.frb.org, 513.455.4479