Article by Vincent Ryan Originally Posted on CFO.com
Regulated deposit-taking institutions often eschew extending credit to the risky small and midsize businesses that land capital through alternative lenders. But those banks are also missing opportunities among the creditworthy businesses that new market entrants are glad to grab.
The primary evidence of this is in the retail industry, where small and midsize online merchants that lack a brand like Wal-mart’s “find it virtually impossible to arrange working capital or inventory loans and the like through traditional banking sources,” according to a recent report by Aite Group, a financial-services research firm.
Why? The answer is simply that banks don’t understand e-commerce providers and fundamentally don’t know how to lend to them, says Christine Pratt, an industry analyst at Aite Group. Banks that earn their spread lending to Main Street businesses are encountering difficulties as bricks-and-mortar retailers disappear or move online.
What’s more, banks have new competition in this space. Enter Amazon.com and Kabbage.
Kabbage is an online lender that has developed a leading position in “social underwriting — incorporating e-commerce volume data and analytics as a foundation for evaluating online merchants’ credit performance,” according to Aite Group.
Kabbage’s “data context engine” taps nontraditonal sources of underwriting information — social media comments, shipping and delivery data, and payment flows, among others — to understand the health of the retail business that is applying for credit. For example, Kabbage has a partnership with online consumer-review serviceYelp to collect data on reviews of its prospective borrowers. “If a vendor has a lot of bad marks or consumer complaints on Yelp that gets added into the [underwriting] mix],” says Pratt.
If the name Kabbage doesn’t strike fear into banks’ hearts, another new capital provider to merchants should: Amazon.com. For the past year, under a program called Amazon Lending from Amazon Capital Services, Amazon has sent letters to its biggest and best merchant partners to offer them pre-qualified loans to boost working capital. According to the ChannelAdvisor blog, Amazon’s interest rates are lower than what credit cards offer, and the funds clear faster than a bank’s. The monthly loan payment is automatically deducted from the merchant’s Amazon Seller Account and the merchant is required to use the capital to increase sales through Amazon, not other online channels.
“Every time a consumer buys something from Amazon, [it] sends them an email that asks if the merchant did a good job,” says Pratt. “So Amazon has that piece of data [about merchants’ performance]; they don’t have to go to Yelp.” In addition, since Amazon moves merchandise for these e-commerce vendors, it has information about what products are being bought, shipped and even returned, as well as stats on payment trends, Pratt says.
To banks, analyzing such information is foreign, if not impossible. Banks have never had good financial data on small, nonpublic companies, much less on online businesses, Pratt says. And as highly regulated entities they don’t have access to the information on consumer relationships that Kabbage and Amazon rely on. U.S. regulations prohibit the sharing of some personal information, including a borrower’s personal information, between retailers and banks, while “the Kabbages and Amazons of the world have no restrictions on what information they can use,” Pratt says.
Still, banks won’t be entirely disintermediated. Some of the capital providers with new models are actually opening doors for deposit-taking institutions.
BoeFly.com, for example, is an online market for small to midsize commercial loans. It has more than 3,600 lenders on its exchange, including 600 banks with more than $3 billion in assets. Boefly is more than a loan broker or comparison shopping site. It has a decision-making technology that “matches information on business borrowers’ application with lenders’ risk and credit parameters,” says Aite Group. The bank or other lender is alerted when a borrower that fits its profile has filled out an application for a loan. The banks pay a membership fee but don’t have to invest in new systems to evaluate these loans, points out Pratt. Borrowers pay $149 for applying and a few hundred more to get help from a loan specialist.
Boefly is also specialzing in offering financing options to franchise businesses, which have had particular difficulty accessing capital from banks since the collapse of the home equity line of credit market.