Dec
11
2013

A New Credit Paradigm May Be Emerging as The Post-Recession Economy Improves

The broader acceptance of alternative lending practices may be here to stay

tornado

Like a ravaging tornado let loose on the American plains, the Great Recession cut a wide swath through one of the nation’s most important economic engines – small businesses.

According to U.S. Census Bureau figures, as a result of financial turmoil, more than 200,000 small businesses were shuttered between early 2008 and 2010 alone, taking along with them the jobs of more than three million workers.

Traditional loans and lines of credit were often impossible to get during those difficult days, frustrating small-business owners who were starved for capital (particularly since the home equity capital well dried up prior to 2008). As these traditional lenders moved away from the majority of small businesses in favor of lending only to top tier customers (who did not want to borrow), more nimble alternative players stepped in to fill the void.

To stay in business, small-business owners had to obtain equipment, supplies and other business necessities. They took whatever path was available to satisfy that need, often despite higher interest rates when compared to banks.

One source readily available to small businesses was non-financial trade credit – credit extended by suppliers who let them buy now and pay later for purchases – which is considered something of a shock absorber for small firms when money is at its tightest. For example, a small business owner could apply for credit directly from the retailer, and if approved, open an account with which to make purchases. As long as balances were paid in full each month or in accordance with other agreed-to terms, the account remained open and in good standing.

In some cases, small-business owners opted to apply for credit cards issued by the retailers. Often, loyalty programs accompany these trade accounts, offering incentives to keep small businesses returning for more purchases.

Other alternative lending sources also emerged, such as peer-to-peer lending that allowed small-business owners to borrow money without need of a traditional financial institution acting as an intermediary.

Now as reported in the Experian Moody’s Analytics Small Business Credit Index for Q3 of 2013, credit quality is improving with credit balances rising and delinquency rates falling.  Interestingly, financial lines of credit comprise just a quarter of the data used to calculate the Index, with the balance of the data made up of non-financial trade lenders, such as those office supply chains that signed up small businesses during the recession. This is significant as it indicates that the majority of credit activity is happening among non-financial lenders instead of traditional funding sources such as banks.

Q3-Delinquency

The report cites that the net share of banks loosening credit standards for small businesses has risen, causing some small companies, but certainly not all, to seek credit the old-fashioned way – through bank loans. At the same time, trade credit grantors appear to be following the banks’ lead, seeking to keep the accounts they established during the recession and to increase revenues by continuing to open more accounts.

An SBA study suggests that bank credit and trade credit complement one another, with two in five small U.S. firms consistently using credit of both types. This has important implications for fiscal policy, as the administration and Congress look for ways to stimulate credit provided to small businesses. The SBA suggests that bank lending and trade credit be viewed as equally important source of capital for small businesses and believe that proposals should explore how to expand trade credit offered by suppliers, as well as how to expand bank credit offered by financial institutions.

So as the battle for small-businesses heats up, will traditional lenders recapture many of these customers or will they remain loyal to their alternative sources of credit? As the old Nora Bayes song lyric goes, “ How ‘Ya Gonna Keep ‘Em Down on The Farm After They’ve Seen Paree?” In other words, alternative lenders came through during their hour of need, while the banks largely passed them by. Will they now return to the old ways?

Ultimately, small-business owners will have to decide. Does faster service, minimal processing requirements and other benefits of alternative financing – despite higher costs – outweigh the lower costs but slower processing and more stringent application requirements associated with traditional bank loans?

The bottom line:

Major occurrences like revolutions and recessions create changes. Some become permanent. This time a new credit paradigm may be emerging as the small businesses that moved away by necessity from traditional lenders in favor of alternative credit solutions may not return to business as usual.

Want deeper insights into Small Business Credit?  Watch the most recent Experian Quarterly Business Credit Review Webinar for Q3 2013.

 


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