Negative interest rates could be an opportunity for challenger banks

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Major UK bank RBS might start charging businesses to accept deposits if UK interest rates turn negative, according to the BBC.

For challenger banks, which typically offer higher interest rates (around 2%) than legacy banks (less than 1%) on deposits, this could present an opportunity to attract small business customers and boost deposits. Growing deposits is important because banks generate interest revenue by lending out money from deposits to other customers.

The banks can leverage a government policy that makes it easy for small businesses to switch accounts. Businesses typically don’t switch bank accounts because doing so is time-consuming and complicated. But for small businesses, the government’s Current Account Switch Service (CASS) requires banks to transfer direct debits and standing orders to new accounts on a customer’s behalf.

Small businesses have been slow to use the service so far, with it making up only 2.5% of switches. This is likely because there hasn’t historically been much difference between accounts. By promoting the service, challenger banks can let small businesses know its easy to take advantage of their superior rates.

Challenger banks will also need to promote themselves and create business products. The four biggest banks in the UK hold 85% of small business accounts, despite the fact that 15% of these small businesses would consider moving their accounts.

This suggests that small businesses are not yet aware of challenger banks or the benefits they can offer. And many challenger banks do not offer products for businesses, which means that they will have to add business products to their product roadmaps to take advantage of the opportunity.

Meanwhile, in the United States, small businesses represent 99% of US companies, 54% of total sales, and 55% of all jobs, according to the US Small Business Administration.

These businesses need capital in order to grow, but small businesses are underfunded — only half of small businesses with $100,000 to $1 million of annual revenue received at least some of the financing they applied for from large banks in late 2015. This is partially because banks have retreated from this segment because issuing loans to small businesses using the traditional underwriting model is expensive. This leaves a massive amount of unfulfilled loans that we estimate reached $96.5 billion in Q4 2015.

Alternative lending companies have stepped in to capitalize on the opportunity available in helping meet more small business’ lending needs. Alternative small business lending platforms use machine learning and digital tools to extend credit to a wide array of small businesses quickly and efficiently, particularly to those that have been rejected by banks. Alternative small business lending companies provide digital platforms that connect small business borrowers to capital using nontraditional means.

We estimate that alternative small business lenders originated $5 billion and had a 4.3% share of the small business lending market in the US in 2015. But alternative small business lending platforms will originate $52 billion and gain a 20.7% share of the total market by 2020, driven by the continued growth of new players, increased borrower awareness and interest, and most importantly, major partnerships with big banks.

Evan Bakker, research analyst for BI Intelligence, Business Insider’s premium research service, has compiled a detailed report on small business alternative lending that analyzes the market opportunity for alternative lenders, forecasts the market share and volume growth of alternative lending platforms, profiles key players, and addresses the main industry risks.

Here are some key takeaways from the report:

  • Alternative lending platforms are in a position to capitalize on this underfunding and also take share from banks. These companies use machine learning and digital tools to extend credit to a wide array of small businesses quickly and efficiently. We estimate that alternative lending companies’ share of the small business lending market in the US will reach 20.7% by 2020.
  • Alternative lenders are now partnering with banks and this will propel growth going forward. New lenders are finding opportunities to offer white-label services to major banks. We expect banking partnerships, like the one between JPMorgan and OnDeck, to add 7.7 percentage points to the alternative lending industry’s market share by 2020.
  • A flurry of new lenders have entered the market, but it’s still early innings. A handful of small business lenders, from Funding Circle to Credibly, have entered the market and this is creating challenges as customer acquisition costs rise and alternative lending companies struggle to differentiate themselves.

 

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