A critical analysis of the small business credit gap and alternative lenders' strategies to effectively serve the small business sector

Credit, in the form of a bank loan, is a lifeline for small businesses in the United States. When the human heart stops beating or becomes debilitated, ultra measures are taken to repair it. Credit, like the heart, keeps small businesses functioning, allowing them to provide essential services and goods to the public. Following the financial crisis in 2007-2008, small businesses lost access or found it extremely hard to receive external financing, particularly from a bank. Actions taken over the pursuing years, that were intended to prevent another recession, may have inadvertently affected banks’ ability to give credit to small businesses. Furthermore, this created a market for small business financing, and now a group of technology firms, referred too as alternative lenders, appear to be competing for this niche market. The purpose of this research is to analyze the current credit market for small businesses in the United States, and to discover to what extent alternative lenders’ capabilities and operational strategies allow them to effectively fund this market. Pinpointing small businesses’ demand and usage of credit, as well as factors affecting their ability to obtain financing, should be useful in understanding the operational strategies used by alternative lenders. In addition, a complete awareness of alternative lending will provide useful knowledge in determining if alternative lenders are a viable source of credit for small businesses. Conclusively, the research will display the revolution happening in the banking industry and how well performing small businesses might be the missing piece to a robust economy in the United States. A primary obstacle has been the lack of samples of small businesses that specifically detail their financing conditions. The Senior Loan Officer Opinion Survey on Bank Lending Practices, The Federal Reserve Small Business Credit Survey, and The NFIB Small Business Economic Trend Survey were used as samples to try to paint a picture of the credit environment for small businesses. A secondary obstacle involved attaining data on the underwriting models used by alternative lenders. Small businesses are recognized as being naturally risky; therefore, the longevity of alternative lenders depends on their underwriting. Furthermore, obtaining the information on underwriting models proved to be impossible because this information is unique to each firm and is considered to be proprietary. This data could only be replaced with a short-term assumption, which was based on an understanding of how marketplace loans are funded. There were particular discoveries on small businesses’ credit needs and alternative lending. First, alternative lenders put technology at the heart of their business models. Branch banking and manual loan processes take too much time and are extremely costly. Clicking vs. brick and mortar is the new approach alternative lenders are using, and it involves completely online transactions. Overhead costs are therefore diminished, and the loan process is completely streamlined, giving real time loan decisions. Secondly, alternative lenders provide credit to a very niche market that usually requires a lot of due diligence work by banks. It is costly for banks to work in areas where money laundering can take place, such as the gambling and marijuana industries. They also provide credit to an undeserved market of minority and women owned businesses that often find it hard to obtain credit from traditional banks. Third, alternative lending is acting as a catalyst for the financial industry by increasing competition, which yields better products and services for consumers and small businesses. It is also forcing the banking industry to adapt to the digital age. The most important finding is that alternative lenders have the potential to jump-start the economy by providing credit to small businesses. Although the resiliency of these firms and their ability to withstand poor economic conditions has yet to be tested, they do provide a new way to access credit. Small businesses provide jobs to half of the private workforce, and they are very optimistic about the future. If alternative lenders continue to provide credit to small businesses, the economy could go from sluggish to a golden era. The United States is near the end of a very long credit cycle, and I would recommend that when the economy starts to decline, research similar to this should be conducted. At that point, a lot more will be known about the accuracy of their underwriting models and their ability to serve small businesses in the future. Regulation surrounding alternative lending will be more transparent at this time as well, which will provide a better picture of what the banking industry will look like in the future. Alternative lenders still have a long way to go before they become a dominant player and will have many challenges on the road ahead of them. For now, we should let alternative lending continue because it is proving to be beneficial for small businesses, and they could ignite the sluggish economy in the United States. However, in the near future, alternative lenders will have more regulatory oversight. The goal should be to find the optimal amount of regulation so that firm and systematic risk is reduced, but not to the point where alternative lenders are unable to fund small businesses