A Critical Look at the Pros & Cons of Non-Bank Financing

Money in a Box

Non-bank financing has grown in leaps and bounds in recent years. Known as alternative lending, non-bank loans certainly play a vital part in the success of SMEs the world over. The fact of the matter is that entrepreneurs struggle to acquire capital financing from the banking industry. Estimates suggest that approval rates hover around 1:3, with lower numbers where stricter requirements are in place. Online lenders include a multitude of non-bank entities.

These companies are prepared to relax the qualification criteria, relative to what banks require, making it easier for small businesses all over the world to qualify for loans. Online alternative lending practices use a combination of readily available technology to determine who qualifies for loans. Foremost among these online resources are the following: accounting software, credit bureaus, and social media profiles like YouTube, Facebook, Twitter, Instagram, Pinterest, and others.

A variety of non-bank lending options has emerged in recent years, noteworthy among them credit cards, lines of credit, short-term loans from payday loans companies, intermediate-term loans, merchant cash advances and others. Each option is generally associated with much higher interest rates than traditional bank loans. The reason being: the qualifying criteria are more relaxed, the loans are more accessible, and the non-bank loan approval rates are much higher. For example, traditional financing options are associated with an 82% chance of denial, as bank lending to SMEs has declined precipitously since the Global Financial Crisis.

Research Suggests Growing Demand for Non-Bank Lending

A leading information portal for small business financing in Australia, Small Business Loans Australia, conducted extensive analysis of the non-bank lending market to determine the eligibility requirements, funding availability, loan processing times, and SME requirements for loan approvals. Non-bank lenders share many characteristics, notably: limits on the number of documents required for processing loans, and substantial funding amounts from around $5,000-$500,000 +, depending on the specific lender. All applications and approvals are processed entirely online.

The beauty of financing through non-bank lenders is that they typically do not require collateral to secure a loan. This places less of a burden on individuals and companies. The onus is on lenders’ ability to collect, and not on borrowers to repay. The costs of short-term financing through non-bank lenders are naturally higher than traditional lines of credit. Many SMEs accept the higher rates for a variety of reasons, notably that they cannot secure loans any other way.

  • Lines of credit typically incur fees starting at 5%, with Annual Percentage Rates (APRs) of 30% +.
  • Short-term loans with a duration of 3-18 months have interest rates of 18% on the low end and 50% + on the high end.
  • Intermediate-term loans require borrowers to repay the loan twice a month, and interest rates range between 8% and 25%.
  • Merchant cash advances have APRs in the region of 50% + and rank among the most expensive alternative financing options available to SMEs.
  • Invoice discounting and invoice factoring are another option available to businesses, but fees can include annual interest rates of 50% +
  • Peer-to-Peer lending options come with interest rates hovering around 5.99% with loan origination fees and terms of 1-5 years with companies like Funding Circle. At Lending Club the interest-rate lies between 5.9% – 25.9%, with loan origination fees too.

Many people are rightly concerned about the high interest rates on non-bank loans. Truth be told, without this industry, many small businesses would close up shop. Since many bricks and mortar banks eschew the issuance of loans under $150,000, this created a natural incentive for the FinTech industry to fill the void and offer non-bank loans to SMEs that would otherwise not qualify them. High credit scores, accounting data, regulatory constraints, and bureaucratic red tape make it difficult for SMEs to approach banks. High annual interest rates in the region of 8% – 60% are concerning, but the opportunity cost of not being able to secure a loan at all is detrimental to the very existence of the business to begin with. Rather than forgoing the opportunity to get a business up and running, or to keep the lights on, SMEs which otherwise would not qualify for bank loans at interest rates of up to 8% are turning to non-bank lenders for assistance.

Traditional lenders still dominate the industry by a long margin. Yet, without the non-bank sector, jobs would be lost, businesses would be closing left, right, and centre, and overall economic activity would suffer. Without sufficient cash flow, businesses will shutter operations.