In the late 2000s alternative lenders like Lending Club and OnDeck emerged and began offering loans directly to borrowers online. Touted as “disruptors,” these lenders sought to challenge the current banking system that they deemed to be broken and grant more consumers and small businesses access to credit. On the surface it would seem as though these startups are looking to go head-to-head with the big banks. However the truth is that alternative lending has found its own place within the modern banking system and actually serves to compliment the services of traditional banks.
Big Banks Versus Small Banks: The New Millennium Loan Market
Prior to the birth of alternative lending, the vast majority of personal and business lending was done through banks. Just prior to the dawn of the new millennium, smaller banks actually granted more loans than the large one. However, according to The Wall Street Journal, smaller banks (those with less than $10 billion in assets) have been losing market share of consumer loans to large banks since 1990 when nearly 80% of loans were issued by small banks. In a huge reversal, large banks account for around 90% of consumer loans today.
There’s no doubt that financial crisis of 2008 contributed to the changes in the banking industry. While loan operations at traditional banks took a hit, online lenders suddenly found themselves playing an important role in consumers’ access to credit. In fact the crisis arguably enabled Lending Club and other alternative lenders to flourish during one of the worst economic times in recent history.
Alternatives to Traditional Banks: Online Lenders
Two of the biggest most talked about online lenders that service small businesses are OnDeck and Lending Club. Since both companies went public late last year they’ve frequently been spoken of in the same breath. While both lenders pride themselves on their efficiency and improved ways of measuring credit worthiness, their loan models are actually quite different.
Lending Club offers loans through what is known as peer to peer lending or marketplace lending. Basically once a loan application is approved and rated by Lending Club, the financial details of the application are listed on the company’s online platform. From there investors can fund all of or part of any given loan in exchange for a piece of the interest the borrower will pay over time.
One of Lending Club’s biggest goals is to bring transparency and efficiency to the banking industry. This is achieved in part thanks to the low overhead associated with operating strictly online. In turn the company is then able to offer lower rates to borrowers than they’d get from a credit card while simultaneously returning more money to investors than they would see from savings accounts.
In 2013, Lending Club’s CEO Renaud Laplanche told Forbes, “Our mission is to make credit more affordable to consumers and businesses. We believe that responsible credit is an engine of economic growth and job creation.” As part of that initiative the company has recently increased their limit for small business loans and now allows them to borrow up to $300,000.
On the other hand, OnDeck offers small business loans from their own capital as opposed to using the peer to peer model. Also unlike Lending Club, OnDeck focuses exclusively on small business loans and allows companies to borrow as much as $250,000. The company evaluates the strength of each business using 2,000 data points in order to make their loan decisions.
Despite the somewhat different approach, OnDeck’s CEO Noah Breslow has echoed some of the same goals as Laplanche and Lending Club. Following the company’s IPO last year, Breslow told Wired, “Financial technology and lending is one of the last industries to be transformed by the internet. Technology and big data play a role in expanding access to credit in this market.”
Bank Partnerships with Online Lenders
In a recent article dispelling several myths about marketplace lending, American Banker argued that online lenders like OnDeck and Lending Club don’t actually directly compete with banks. To support this, the article points to the fact peer to peer and alternative lenders have consistently formed partnerships with banks that have been beneficial to both parties as well as consumers. This is especially true when it comes to smaller, struggling banks.
Earlier this year peer to peer leader Lending Club formed a partnership with BancAlliance. Under the deal more than 200 small community banks that were members of BancAlliance were able to offer co-branded loans to their customers using the Lending Club platform. Not only does this bring more business for Lending Club but it also allows small banks to loan while minimizing risk.
Alternative lenders like Lending Club and OnDeck are looking to change the banking industry and help small businesses get loans. However this doesn’t mean they are a threat to the current banking system. In fact, as we’ve seen through recent partnerships, these online lenders can work in conjunction with traditional banks in order to meet the demand for small business funding.