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Banks are falling behind alternative lenders

Aug 03, 2015 Sean Albert

Banks are falling behind alternative lenders

The Great Recession was brutal for the banking industry, and it caused a significant shakeup in lending strategies. Prior to the economic crash, banks were distributing capital at high rates, but the crisis forced them to close their checkbooks and establish new criteria for borrowers to meet.

However, lending rates from traditional sources have remained low, and many loan-seekers turned to new resources for funding.

Alternative lenders have taken over the market

Forbes contributor Rohit Arora wrote that the loan approval rate in the banking industry dipped as low as 8.9 percent at the peak - or valley, depending on your outlook - of the recession in 2011. Arora reported that between 2008 and 2012, lending volume plummeted by 19 percent, reflecting the grim economic climate of the time.

Unfortunately for banks, by the time they recovered from the crash and stabilized, finding themselves in the position to be able to offer more capital to borrowers, alternative lenders had already usurped them as the dominant providers in the market. Arora pointed out that this development is rather self-inflicted - had the banks not been so stingy for years, people likely would not have sought out different resources.

Alternative lenders were more willing to take on risky debt, Arora said, sometimes charging borrowers high interest rates to serve as an insurance mechanism. In many cases, those who were considered to be high risk applicants received funding and were able to use it to effectively expand their businesses. The author noted that while banks are now more willing to lend, their approval rates are still far lower than alternative lenders - he said they now grant 22.1 percent of loan applications, while their alternative counterparts generally approve more than 60 percent of prospective borrowers the sum they're looking for.

Perhaps the biggest sign of market dominance by the alternative sector is the following statistic. Arora reported that prior to the recession, 80 percent of small businesses applying for loans contacted a bank first. Now, on the other hand, 80 percent of applicants are turning to online lenders first, with a further 60 percent of that group applying from a mobile device. The game has changed, and the banks have failed to keep up.

Which funding options are borrowers choosing to use?
The Huffington Post contributor Marc Prosser compiled a list of some of the more popular types of alternative lending that borrowers are seeking out. He noted that a big development has been the establishment and growth of the peer-to-peer lending market, in which third party resources connect prospective loan-seekers with investors who are willing to provide capital to entrepreneurs.

Prosser also reported that short term loans are becoming an increasingly viable option for small businesses and individuals. Despite their generally high interest rates, they can serve as a temporary means to support the daily operations of a business. For organizations whose profits are received in periodic lump sums due to larger-scale transactions, this option can provide short term relief while waiting for a payment to be processed.

The banks seem to have had their lending dominance rescinded in recent years, and they do not currently appear capable to reclaim it from alternative lenders.