In March 2015, the Center for Impact Finance at the Carsey School of Public Policy at the University of New Hampshire convened the 16th Annual Financial Innovations Roundtable at the Federal Reserve Board in Washington, DC. The objectives of the proceedings were:
- To understand changes in the small business lending marketplace that affect community development lenders and the small business customers they serve
- To identify and begin to advance ways for Community Development Finance Institutions (CDFIs) and other mission-based lenders to take advantage of, and shape technological developments that can improve small business access to credit and encourage growth of the small business lending marketplace
Sam’s Club Giving provided the Carsey School of Public Policy research funds to examine the emerging online small business lending sector—a part of the broader “fintech” (financial technology) sector—and its relationship to and effects upon CDFIs. The Carsey School conducted 25 interviews with both CDFIs and online business lending industry stakeholders, compiled data and reviewed literature on the current state of both industries, and examined initiatives in which CDFIs are partnering with online business lenders or are applying fintech in some way to their work.
Several key themes emerge from this research:
Online small business lenders are greatly outpacing the CDFI industry in terms of the number and volume of loans they are producing.
Leading online lenders are now originating billions of dollars in loan volume per year—for example, in 2015, Lending Club made $11.4 billion (which includes both business and consumer loans) and OnDeck made $1.6 billion in loans. CDFI Fund statistics suggest that the entire combined CDFI industry would be a small player next to these lenders. The most recent CDFI Fund statistics are for 2014, and only CDFIs that have received awards from the Fund in recent years are required to report. All reporting CDFIs indicated making $685 million in business loans in 2014.
Individual CDFIs, even leading ones, have much smaller volumes. For example, according to financial audit data, in 2015, Opportunity Fund lent $37 million, Coastal Enterprises $20.6 million, and Craft3 $77.4 million. Small CDFIs may originate less than $1 million in business loans in a given year.
This disparity is also seen when looking at the number of loans made. OnDeck, for example, made 37,141 loans in 2015, compared to 4,078 for all reporting CDFIs in 2014.
Some of the competitive advantages that online lenders employ to achieve this higher level of production include technology that enables much faster customer response times, greater investment in marketing and customer acquisition, and scaled relationships with the capital markets (which are in turn enabled by the design of loan products with market returns).
Nevertheless, CDFIs have unique capabilities that could help them continue to be relevant and impactful players in the business lending space, provided they can adapt to the new environment.
Both online lenders and CDFI stakeholders we interviewed recognized the ability of CDFIs to provide borrower education and technical assistance. Some interviewees viewed this ability as complementary to online lenders’ ability to deliver loans, while others saw this ability as a way for CDFIs to lend to a class of borrowers that other lenders cannot reach. A number of interviewees cautioned, however, that to the extent that CDFIs rely on craftsman-like, “high touch” methods, they will fail to achieve scaled impact and will suffer serious disadvantages in terms of the cost and timeliness of loan production. CDFIs are thus left with the difficult challenge of attempting to use new technology to streamline their operations as much as possible, while still offering some of the unique customer service that sets them apart.
Some interviewees highlighted product differentiation as a strategy for CDFIs. This is exemplified by the comment from Jacob Haar of Community Investment Management: “CDFIs fill a critical gap in small business finance by offering affordable loans and technical assistance to borrowers on the lower end of the credit spectrum who otherwise may not quality for affordable capital online.” CDFIs may indeed have opportunities to educate business owners that borrowing from them a better option, to serve borrowers who have been denied by online lenders, and even to assist borrowers who need to unwind debt from online lenders. On the other hand, CDFIs have been constrained in capitalizing these products, and may need to adopt more standardized products if they want to scale up their lending activity. Moreover, other interviewees felt that CDFIs actually lack product diversity and thus do not have a competitive advantage over online platforms.
Fintech in general, and the growth of online business lending in particular, present new opportunities for CDFIs to create new marketing channels, generate operating efficiencies, access capital, and improve customer service.
Most interviewees believed there was significant potential for business lending CDFIs to improve their business results by adopting new financial technology, whether through partnerships with online lenders or through other pathways towards platform development. While most comments centered on opportunities to gain efficiencies in core operations and underwriting, other interviewees talked about how financial technology could help to improve the customer experience or access new capital. One example of the latter opportunity is the TILT Forward Initiative, in which CDFIs can access customers referred by banks and nonbank lenders as well as credit products from third parties capitalized through a wholesale relationship with Dream Fund.
In addition to the TILT Forward Initiative, there are a number of other specific business opportunities in which business lending CDFIs that have not yet integrated fintech strategies could participate. We describe a number of these specific business opportunities for CDFIs, such as partnerships with online lenders and fintech companies, in the body of the report.
CDFIs that are unable to adapt may be left behind. This creates concern about whether and how smaller CDFIs, as well as CDFIs who wish to pursue highly unique business models, can participate in the fintech revolution.
The ability of a CDFI to participate in partnerships with online lenders, or to afford the adoption of new financial technology platforms, is at least in part predicated upon that CDFI’s production volume, as well as its willingness to adopt some standardized products into their mix of offerings. Online lenders made it clear in our interviews that they cannot invest in building “one-off, idiosyncratic” relationships with large numbers of CDFIs. And even off-the-shelf technology solutions, such as Community Reinvestment Fund’s SPARK software, are geared towards CDFIs with at least 100 originations annually. On the other hand, the Association for Enterprise Opportunity (AEO) notes that the TILT Forward Initiative was designed to accommodate even small CDFIs by creating virtual scale and access to product, capital and marketing solutions.
A number of interviewees also cautioned against “go it alone” approaches to platform development. They suggested that the CDFI industry’s success is tied to networks of CDFIs entering into partnerships to apply a fintech solution across their markets.
To summarize, CDFIs face a number of important strategic decisions in how to respond to the changing business lending environment.
To learn more, contact Michael Swack, Director, Center for Impact Finance, Carsey School, UNH.
To read the full report click here.