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Why alternative financial services are growing in popularity

Dec 17, 2019 Sean Albert

Banks typically favor lending to established companies and individuals due to the assurance that their investments will be repaid. However, a largely underserved market - composed of small business owners and people with unqualified credit histories - often need loans, too. This void in funding is largely being filled by the rapidly growing alternative financial services industry, which does not enforce such rigid restrictions.

Alternative financial services has become a massive and lucrative industry
Payments Leader cited FDIC data that estimated the AFS industry to bring in approximately $320 billion annually. The source said that, in all likelihood, this figure is on the conservative side due to the various components that make the industry tricky to define and record. Payments Leader listed auto loans, check cashing,short term loans and remittances as the leading categories, but clarified that there are many other aspects that comprise smaller, low profile funding and are therefore left out of the data.

The source said that AFS providers are experiencing such profitability because of their innovative nature. As technology advances, companies accordingly adapt and find new ways to gain advantages over competitors. They are more accessible and convenient to customers, and even fee installments that formerly incited apprehension among prospective borrowers have been amended to loosen repayment restrictions and allow for greater flexibility.

The demographic targeted by AFS lenders has increasingly leaned toward families without existing bank relationships, as it is nearly impossible for these parties to qualify for traditional loans. This category's number of constituents is growing, and so the demand for AFS has also greatly increased to reflect their needs.

AFS is relatively new, and has fewer regulations than traditional lenders
American Banker suggested that one of the primary reasons AFS providers have been able to expand so rapidly is that the industry itself has not been regulated as closely as traditional lenders, due to its newness and unpredictability. This is a huge advantage for lenders, but it is not likely to last, the source said. As the industry becomes more clearly defined and structured, it will be more susceptible to being even more heavily regulated, like other areas of finance.

While this distinct upper hand is welcomed by AFS providers, regulations are inevitable, so American Banker warned not to get married to the idea. While banks are subject to numerous lending restrictions, both self-imposed and otherwise, AFS lenders have for the most part avoided some of them. For now, they maintain an advantage over big banks in this regard.

Rigid restrictions imposed by the banking industry lock out a large number of small business owners looking to expand their companies and individuals who simply need short term loans to make payments. However, those with unqualified credit histories can find solace in AFS providers, which are far more welcoming to such customers. The success of the industry can be traced to both its accessibility and its - as of now - relatively open nature. How AFS will continue to grow in the future is unclear, but for now, it serves a vital function for many without access to bank funding.