Traditional financial institutions do not serve the customer well when it comes to borrowing.
In consumer borrowing, mainstream financial service providers tend to lack flexibility – not only in their opening hours, but in taking a very vertical view of a potential customer. This produces by necessity a black and white view – ‘good customers’ and ‘risky customers’, in a market that typically includes many shades of grey; and means many legitimate borrowers cannot access loans through mainstream banks.
In SME finance, traditional banks have found themselves needing to limit the flow of capital after the Basel III banking reforms, resulting in a lack of available cash for SMEs across Europe.
Alternative finance, on the other hand, lends to customers who are underserved by traditional banks; both in consumer and business lending.
Serving the Underserved
One key barrier to many customers accessing finance through traditional institutions is credit rating. Many traditional banks operate a system whereby customers assessed as having a risk of default under one percent can access a loan more or less automatically. Customers assessed as having a risk of default above 10% are deemed ‘not creditworthy’. This leaves an ‘indeterminate population’, who have a risk of default between 1-9%. They might just lack enough credit history, but this makes getting finance from a mainstream institution difficult.
Alternative finance is able to access this market, and for many investors the ‘indeterminate population’ still remain an attractive proposition. Alternative finance’s approach of assessing this group by means of both traditional credit scoring methods and big data, is better for both the customer and investor.
Where platforms share information about the reasons for borrowing, a pattern emerges across different European geographies. All across Europe, regular people are using alternative finance sources to make improvements to their daily lives. In Bondora’s case, 24% of loans made are for the purpose of customers redecorating their homes – an investment for both the value of their property and their comfort. 21% of loans are used to pay back existing debt through consolidating at a more favorable interest rate. Zopa in the UK list a very similar selection of reasons – paying for a car, paying off credit cards and decorating the home as the three top motivations for borrowers take loans through them.
Fuelling the SME Ecosystem
Global financial crisis and the Basel III regulations have resulted in a funding bottleneck for SMEs across Europe. Alternative finance, by matching the needs of customers and investors, is able to step in, with capital being made available to solid businesses quickly, with limited bureaucracy and reasonable rates. A recent survey of 1000 small businesses, found that of the 30% who had sought alternative finance loans, 89% of loans were granted in full or part. At the same time, 33% of peer business lending customers believe they would not get any funding at all through a mainstream lender.
What is especially interesting is that in figures reported in the UK, 63% of those who took business loans through alternative finance providers reported an increase in profitability as a result of the loan. As a significant proportion of these customers would not have been granted access to capital by a traditional lender, this is potential profit that is only realized because of the alternative finance sector. In this way, alternative finance is fueling the SME ecosystem across Europe where traditional banks are failing their business customers.
Mainstream financial services institutions leave many potential customers – both business and individual consumers – out in the cold. Alternative finance challenges this, ensuring the access to credit and capital that is necessary for economies to grow and flourish, both disrupting and building new models that can open up banking to underserved customers in Europe and beyond, while creating also a wealth of opportunity for investors.