Our financial ecosystem has become digitally driven, in turn allowing more formerly unbanked and underbanked communities access to fair and equitable financial services while providing merchants and vendors with more affordable transaction solutions.

Despite all the advancements, a large portion of small and medium-sized enterprises in the United States are having a hard time accessing credit, which in turn helps them apply for short-term funding to help grow their businesses.

One survey of around 500 small business owners has found that more than half of them - or 53 percent - currently have “no access to credit.” The same survey revealed that those small businesses making $150,000 or less in annual revenue have the hardest time accessing affordable credit.

These limitations cause wider obstacles for business owners in the short and near term, which often makes it difficult for them to invest in the expansion of their operations, and develop new products, and can lead them to fall victim to more predatory financial practices.

However, the widespread adoption of fintech is helping to change this. During the pandemic, online lenders, including neobanks were the third most popular source of credit to which small businesses applied, according to data collected by the Bipartisan Policy Center.

In fact, in 2023, around 44 percent of small business owners applied for loans at larger banks, while 28 percent did so at smaller regional banks and 23% applied for loans via a fintech company.

Fintech lending and fintech banks are booming. Consumers, merchants, and entrepreneurs are leveraging digitally-enabled financial services as an alternative. In a short time, fintech banks have taken up a more important seat at the table, and could quickly become the number one alternative for small business credit.

Why Fintech Has Become A Popular Choice For Small Business Lenders

Fintech does more than provide business owners and consumers with a new way to access financial services. Instead, fintechs have removed traditional barriers to entry, and have replaced legacy systems with advanced real-time digital solutions.

Business owners especially are looking to have more equitable access to the necessary financial capital they require to scale their businesses. In a market where technology is driving competition among organizations, those late to adapt will find it difficult to make an impression on their customers.

Accurate and Fair Credit Scoring

Traditionally, banks require owners to have an existing credit score to apply for any form of credit or loan. These lenders often use metrics such as existing loans, payments, and other debt as a way to determine a person’s creditworthiness.

This has created a double-edged sword in many cases. An owner, looking to take out a loan, for the first time, will need to already have some form of credit or debt in their name to qualify. This not only prolongs the process but excludes a larger percentage of hopeful entrepreneurs.

Instead, some fintech companies are taking a different approach, looking to review an amalgamation of different bills, social security, and other financial metrics to determine a person’s creditworthiness. This in turn creates a more holistic approach, which could make credit more affordable for many owners and entrepreneurs.

Using a host of data sources available, fintech companies can compile a more accurate picture of an individual’s financial well-being, and leverage key metrics to determine an applicant’s level of risk.

Personalized and Tailored Offerings

More people demand a personalized experience, and financial products have undergone similar changes in recent years, which allows banks and financial institutions to make more accurate determinations regarding an individual product.

However, this might not always be the case. In some instances, banks will have a selected number of products due to a lack of demand from the market, pricing challenges, or unable to fulfill technical requirements. This in turn makes it difficult for any individual or business owner to find a short or long-term financial credit solution that’s tailored to their needs.

Fintechs have in return delivered an answer to this need, leveraging data analytics to track the overall demand of business owners. Part of this is to make products not only more attractive to a wider pool of customers but to ensure borrowers have more choice in terms of the products they are looking for.

Lower Lending Costs

Having more cooks in the kitchen - an intermediary, loan officer, or credit union - drives up the total cost of servicing a loan. Not only this, but banks tend to charge an interest rate that is similar to that set by the U.S. Federal Reserve.

In the last few years, interest rates have skyrocketed, in turn leaving many banks to increase rates for borrowers, and tightening lending standards. In fact, one report found that around 49% of big banks had increased lending standards for small firms in 2023, an increase from 22% a year before.

The equation looks somewhat different when it comes to fintechs. Digitization of many processes has meant that fintechs can remove intermediaries, creating more opportunities for peer-to-peer (P2P) lending. This makes it easier, and more affordable for smaller businesses to directly borrow from a fintech company, reducing not only the costs of servicing a loan but avoiding the middle man altogether.

Faster Digital Loan Processing

Getting approval for a loan can take days, often weeks, and in some cases months. The time it takes to receive approval largely depends on which type of loan an individual is applying for, and at which institution.

For instance, loans from the Small Business Administration (SBA) can take anywhere from 30 to 90 days. A small short-term loan at a bank can take up to five weeks to process, depending on the financial institution.

Underwriting standards are different across the board, but innovations in technology have made it possible for some fintech companies to underwrite and approve a loan within a few hours. These instances are not equally shared across all fintechs, but the general assumption is that more tech-driven banks or fintechs will often promote better, and more secure digital lending.

“Processing a loan takes time and there are plenty of moving parts that need to be considered during the underwriting process,” says Daniel Azzoli from CreditFresh. “Banks often don’t have the human or technical capabilities to handle a large amount of loan applications, resulting in delays, and further prolonging the process for many business owners. Fintech can help fix this issue, and reliance on technology has already proven highly successful,” he says.

Online Applications

Business owners already have enough to deal with, and taking on the grueling work of gathering all the necessary information, completing an application, and having to attend multiple in-person meetings with underwriters only further increases the time needed to obtain new working capital.

While there are major banks and regional financial institutions that have done away with legacy application systems, fintech lenders often lead in this arena, which allows them to process applications faster and provide more accurate outcomes to borrowers.

One of the reasons for this is that many fintech companies and neobanks don’t have a brick-and-mortar location. This means that most of them already have the digital infrastructure in place to handle increased demand, process applications more efficiently, and use data to analyze underwriting criteria.

The Risk Of Fintech Lending

While fintech companies have revolutionized the financial ecosystem, they are still a relatively new addition to the industry. There is still a lot of work that needs to be done in this space, and many legacy banks have long-standing reputations, which could make them more attractive to many small business owners.

Regulatory Considerations: The finance sector is a highly regulated ecosystem, with multiple regulators overseeing the compliance of banks and fintech companies. Newer fintech companies often have a hard time gaining compliance, which in turn could increase risks for borrowers.

Credit Risk: Providing too much access to credit can be a bad thing. By making credit too accessible, fintech banks could increase the risk of borrowers holding excessive debt which in turn could increase interest rates or lead to bigger economic challenges.

Risk Mitigation: Any new business tends to have a lower level of risk mitigation. Only after years of experience in learning how to navigate market and industry challenges will a business and organization become more proficient in understanding how to mitigate potential risks. A similar trend is often noticed with newer fintech companies that have had less industry exposure.

Cybersecurity: Operating in the digital space comes with increased exposure to cyber threats and malicious actors. Fintech companies that do not comply with regulatory safety and security standards often fall victim to cybercrime, increasing the risk of data breaches or having client information end up in the wrong hands.

Fintechs: A Temporary Short-Term Solution

Looking at how much fintech companies have done for small merchants and entrepreneurs proves that there is still a strong demand for better financial services solutions aimed at providing small business owners with access to appropriate financial and credit products.

Though there have been plenty of innovative solutions coming to air in recent years, there are still a host of risks that small businesses should consider when seeking to rely on a fintech for their credit or lending needs.

On a good enough time horizon, banks and fintechs will help deliver more equitable, affordable, and accessible credit to the business owners who have been previously disadvantaged or overlooked. This would further show that technology is helping drive the development of an innovative digital economy.