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by Rohit Arora

Prior to the Great Recession, easy credit conditions prevailed for small businesses. Cash was free flowing, and relaxed practices made it relatively easy to secure financing.

After the Lehman Brothers crash and during the ensuing “credit crunch,” volume fell roughly 19 percent from 2008 until 2012. This general slowdown in lending coincided with stricter requirements placed on borrowers. Financing simply became less available — even for “creditworthy” companies. For the first time in U.S. history, small business owners frequently were unable to secure credit even from their own banks.

Many banks suffered losses when the housing bubble burst, and they became risk averse. In order to make , they often sought three years worth of financial data. Naturally, revenues declined during the recession, and were particularly challenged because they had no financial track record to highlight. Historical data from my company’s Biz2Credit Small Business Lending Index shows that big bank lending hit rock bottom four years ago in June 2011, when only 8.9 percent of small business loan applications were granted.

So what happened during this inefficient ? As bank lending fell significantly, so entrepreneurs looked for other sources. Technology enabled platforms such as Biz2Credit, BoeFly and Lendio, as well as balance sheet lenders OnDeck Capital and Kabbage, to emerge and match entrepreneurs with willing lenders.

Had the banks not shut the spigot so tightly, borrowers might not have been so motivated to look elsewhere. Business owners went online in search of capital in the same way that shoppers adopted technology to find the best deals on consumer goods. These events led to the rise of peer-to-peer lending platforms, such as Kickstarter and Indiegogo, that collectively had provided more than $1 billion in financing for entrepreneurs by 2011.

Alternative lenders (merchant cash advance companies, factors, and others) also took advantage of the opening when banks refused to lend. In return for a percentage of future revenues, they were willing to provide quick, short-term infusions of cash. These lenders were willing to take on riskier debt, and that risk manifested itself in the form of high interest rates, sometimes 30 to 40 percent, that often had to be paid off in six months or less.

The latest major threat to the supremacy of banks has been the rise of marketplace lending, which evolved from peer-to-peer. Now, instead of having individuals fund your company, institutional platforms have gotten into the small business lending game. Insurance companies, family funds, VCs and others are providing billions in capital through online platforms. They make quick decisions like other non-bank lenders, but offer longer terms and much lower interest rates.

Before the recession, about 80 percent of small business owners went to a bank first and when rejected, they turned to the internet to find funding. Today, 80% go online first, and some 60 percent of them are doing so via a mobile platform. Further, almost two-thirds (65 percent) fill out loan applications after 6:00 p.m. and on weekends — times outside traditional banking hours. One cannot underestimate the role of financial technology in this evolution.

Even with all of this change, not one single big bank established its own digital application process for small business loans. The banking industry usually has been on the cutting edge of technological advancements, but in the case of small business loans, customers have moved online faster. This is a dramatic turn of events.

Big banks have steadily increased the percentages of loans that they grant to small businesses. In June of 2014, the figure eclipsed 20 percent for the first time since before the Great Recession. The latest research finds the level has risen to 22.1 percent: good, but not great since nearly four-of-five funding requests are rejected. Meanwhile, smaller banks are approving slightly less than half of the applications they receive. At the same time, institutional lenders tend to fund more than six in ten funding requests at interest rates that rival those of the banks and at a much faster pace.

When banks were unwilling to lend, borrowers went elsewhere. Eventually, overall economic conditions improved and credit eased, but small business owners did not flock back to the banks. They learned that they could get funding elsewhere. Banks have lost an incredible amount of opportunity for two reasons. Firstly, big banks still tend to focus on small business loans of $2 million, even though many entrepreneurs don’t need such large amounts. Secondly, many banks have not invested adequately in technology that allows online small business loan applications ad still tend to favor government-backed SBA loans that take longer to process and require large amounts of paperwork.

The end result is that banks, which did the lion’s share of small business lending before the Great Recession, now are declining as lenders. Their primary advantages — name recognition and the branch system — have eroded, thanks to technological advances. I believe that much of the market share they lost is now gone forever.



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