Lending Gaps and Lessons
posted by Collin Canright on September 14, 2018 - 11:22am
The gap in small business lending, which the easy-money policies of the Federal Reserve were supposed to fill, are well documented. It's more difficult for small businesses to get small loans from banks, in large part because it's less profitable for banks of all sizes to make small-dollar loans.
A Harvard Business School report on the state of small business lending (PDF) shows that "small loans as a share of total loans on the balance sheets of banks have declined in nearly every year at least since the mid-1990s." Fintech lenders have stepped in to fill the gap "through greater innovation in how small business loans are evaluated, underwritten, and managed."
Treasury's plan to legitimize online lenders is good for small businesses
"Less than 10 years on from the last recession, there has been a substantial increase in the availability of capital as well as financing options for small companies. One of those options is online lending," writes Gene Marks in The Guardian.
FinTech firms like Kabbage and Lending Club are getting their due for filling gaps in the innovation report released July 31 by the U.S. Department of the Treasury, which directed the Office of the Comptroller of the Currency (OCC) to allow FinTech firms to apply for special-purpose banking charters.
Although the effort reportedly is off to a slow start, it's seen as a way to bolster growing online lenders, among other FinTech businesses. Marks cites a May 2017 study on line lending by the Polsky Center at the University of Chicago, which shows that the alternative lending industry has grown to more than $35 billion.
Loans from alternative lenders come with a reality that small business owners using the loans understand and accept though don't like. "The financing isn’t cheap. Some of these lenders charge significantly more than even a credit card advance. But when these deals make business sense – a deposit for a real estate lease, a purchase of equipment, a quick inventory buy – even the added costs of these loans are still much less than the benefits receive," Marks writes.
Do you know what your lending customers really want?
Indeed, interest rates are no longer enough for banks to compete, writes John Waupsh, chief innovation officer for bank technology provider Kasasa in Banking Exchange. "What consumers really want is a better experience and more control over how they manage their finances, including debt. Fintech companies know that experience is what drives consumer emotion and therefore consumer choice. This is where banks should focus."
Lenders shunned risky personal loans. Now they’re competing for them.
Banks and FinTech companies "are stepping up offers of consumer loans with few strings attached, often to individuals with poor credit histories they all but ignored in the years after the financial crisis," report Anna Maria Andriotis and Peter Rudegeair in The Wall Street Journal (paywall). "As competition between fintech lenders and banks intensifies, more subprime borrowers are receiving these loans." Currently, just over half of borrowers have subprime credit scores, with the number of approved subprime borrowers in 2017 at the highest level in a decade, according to TransUnion.
First Midwest goes where other banks fear to tread
Banks are increasingly eager to collaborate with online lenders. Chicago-based First Midwest, "saw a need to diversify its lending beyond the commercial real estate that had fueled its growth," reports Steve Daniels in Crain's Chicago Business. "That meant hiring business bankers. But it also meant more lending to the consumers who keep their deposits at First Midwest, as well as those in other states." The bank has moved into unsecured lending slowly but surely, with $377 million in unsecured consumer installment loans on its books as of June 30. (Daniels' article also provides an update on Chicago-based online lending leaders Enova and Avant.)
Total household debt rises for 16th straight quarter
Personal online lending is increasing across the board, the Journal reports. "While the market for personal loans is relatively small, it is growing quickly. Lenders extended $81.9 billion in personal loans to U.S. consumers in the first half of the year, up about 13% from a year prior, according to credit-reporting firm Experian PLC."
"Relatively small" is the key phrase. To put the increase in online lending in perspective, credit-card debt has increased $45 billion so far this year, to $829 billion. Total consumer debt "increased by $82 billion (0.6%) to $13.29 trillion in the second quarter of 2018," rising for the 16th straight quarter, according to the latest survey by the Federal Reserve Bank of New York.
It's also worth noting that the biggest worry with subprime and unsecured lending lies in default rates. They appear not to be a problem at this point. "While overall delinquency rates have remained stable at relatively low levels, transition rates into delinquency have fallen noticeably for student debt over the past year," the New York Fed reports.
The student debt problem is worse than we imagined
A recent opinion piece in The New York Times warns that the average student will graduate college with $22,000 in student debt, far higher for those who go on to professional schools. "There are two ways to measure whether borrowers can repay those loans: There’s what the federal government looks at to judge colleges, and then there’s the real story. The latter is coming to light, and it's not pretty," writes Ben Miller, senior director for postsecondary education at the Center for American Progress.
Have we learnt the lessons of the financial crisis?
Did you hear it's the 10th anniversary of the financial crisis? I'm sure you have, as the coverage has been abundant. My favorite piece so far is Gillian Tett's article in the Financial Times, which documents her coverage of the crisis, ending with a warning on the world's increasing debt.
"This borrowing binge has not occurred in the areas of finance that caused the last crisis, such as subprime loans. Instead, the debt boom is among risky companies and governments, ranging from Turkey (which already faces a financial crunch) to America (where borrowing has accelerated under the administration of Donald Trump.) Meanwhile in China, gross public and private debt has doubled in the past decade to about 300 per cent of GDP. This surpasses even Japan’s wild 1980s debt binge."
Andrew Ross Sorkin made a similar warning in his Sept. 11 column in The New York Times:
Unmanageable debt is the match that lights the fire of every crisis. You can have as many bad actors on stage as you want — greedy bankers, inept regulators, conflicted credit rating agencies — but unless there is significant leverage in the system, there’s little danger of a crisis. Our national debt is more than $21 trillion, and it increased a trillion dollars in just six months under Mr. Trump, who rode populist and anti-establishment sentiment to the White House but whose policy choices have largely favored the wealthy.
Bloomberg's Matt Levin gives a summary of a other crisis articles, all with their warnings and next-crisis theories. None should be taken too lightly.