During the recession that began in 2008, traditional banks became wary about awarding risky loans. Not only had bad deals come back to hurt many institutions, but also new regulations required many banks to increase their capital reserves. With less money to lend, banks largely stopped financing risky endeavors like commercial real estate and small business loans.
To fill this void in the market, non-traditional lenders like real estate investment trusts (REITs) and online outlets increased their presence. Fueled by venture capital, many of these institutions are free from the regulatory constraints facing standard banks. As a result, they can afford to take on riskier clients. For instance, REITs like Starwood Property and Blackstone Mortgage Trust finance the purchase of abandoned malls and high-vacancy skyscrapers for developers. These chancy projects would not likely receive funding from traditional outlets, leading many developers to head straight to REITs when they need capital. While these deals can be lucrative for the lender, the high-risk element means that another economic downturn could send the whole industry into a tailspin.
While these firms ink deals valued in the millions and billions, other online services cater to small businesses. Sites like OnDeck, Kabbage, and CAN Capital use algorithms to approve a business’ loan within minutes. OnDeck, for example, uses more than 2,000 data points per online application to assess approval. Still, like many “fast cash” outlets, these services can charge interest rates as high as 50 percent annually. But as the industry continues to grow, the involvement of more competitors may cause rates to stabilize. According to one small business owner, a company called IOU Central charged him an annual percent rate (APR) of 60 percent for two $15,000 loans. He later received a similar loan from American Express, only this time the APR was just 10 percent. Big banks like these are beginning to move in on this market, which could lead to more loans for small businesses across the board.
- Did stricter government banking regulations help or hurt the economy?
- Should “fast cash” outlets come under closer scrutiny from government regulators?
Source: Eliot Brown, “Nonbank Lenders Step into a Void,” The Wall Street Journal, April 29, 2014; Alix Stuart, “Beware of Sharks: New Rules of Fast Cash,” Inc., May 2014. Photo by Danny Englander.