The April 2015 issue of Governance will examine how the financial crisis...
Online lenders and the evolution of banking
Startups are grabbing the small business market and eyeing larger loans, too.
From CRAIN’S New York Business
By Ronald Fink
April 27, 2014
In 2012, a year after Ben Bohen and his two partners opened Waterfront Wines & Spirits in a condo complex near Brooklyn Bridge Park, the owners needed a round of financing to increase their inventory and advertise more.
Waterfront’s bank, JPMorgan Chase, likely would have wanted much more credit history and collateral than Mr. Bohen and his partners could produce, so they tapped online lending platform OnDeck Capital , and in a few days got a six-month loan of $20,000 based on their cash flow, at a steep annual rate of 19%. (A Chase spokesperson noted that the bank is the nation’s leading provider of loans backed by the Small Business Administration and that it would not necessarily have turned down Waterfront.)
The transaction is an example of a transformation in small business lending, one that is only beginning to be recognized. Since the financial crisis, banks have been ceding that market to a variety of online upstarts that some academics are calling “shadow banks.” Many such companies are now growing at rates of 100% a year or more, and many more are entering the market. OnDeck and Biz2Credit , two of the largest, are based in Manhattan.
Eventually, the new companies, which are making smaller loans more available but charging a lot for them, could compete head-to-head with banks for more profitable, larger loans. “The clash is not [happening] today,” said Ron Suber, president of San Francisco-based Prosper Loans Marketplace, an online platform that matches individual lenders with borrowers around the country. “But it’s hard not to see it in the near future.”
Ironically, the upstarts may be safer for the financial system, some academics argue. Most banks are financed largely by debt: Short-term deposits are leveraged into long-term loans. Most Web-based platforms match borrowers with lenders on a dollar-for-dollar basis. In other words, unlike traditional banks, they employ no leverage at all.
“Shadow banks or any intermediary that is transparent and doesn’t involve leverage is safe, limited-purpose banking,” said Laurence Kotlikoff, a finance professor at Boston University…
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