Fintech and the Future of Small Business Finance

Small business finance is one of the many fields that has been revolutionized over the course of the COVID-19 pandemic. Initial responses to the pandemic created lots of innovations as governments around the world sought to provide relief to residents, businesses and communities.  Along the way, Fintech and on-line lending have cemented their importance as a source of small business finance.  An interesting new Philadelphia Federal Reserve research paper examines these trends, with a focus on The Funding Circle’s loan portfolio.  It’s no surprise that large banks have been reducing their small business lending for many years.  Smaller community banks and non-traditional lenders have tried to close the gap, but many worthy small business—especially those led by minority entrepreneurs—still lack adequate access to capital. 

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Fintechs may be helping to close these finance gaps, especially when they partner with other institutions.  The latest Fed Small Business Credit Survey finds that fintechs/online lenders received 27% of business financing applications in 2021.  On-line lenders are an especially important funding source for less credit-worthy applicants.  The Philadelphia Fed researchers found that The Funding Circle did a better job of assessing loan risks when compared to other tools like the FICO credit rating.  However, we also know that, because they work with higher risk customers, fintechs tend to have higher fees and interest rates.  In addition, Fed surveys suggest they also have lower customer satisfaction rates.   

This analysis suggests that expanded fintech activity can have a positive impact in increasing the availability of small business credit.  If potential risks and downsides of the fintech model, such as higher fees, can be effectively managed, they offer great potential to support a broader and more diverse market of small business owners.