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Stacking, the Invisible Threat in Online Lending

two business persons plan a project

The pendulum has swung again.

The great recession brought a glacial freeze to access to capital.

The thaw brought rapid, frictionless underwriting with an almost obsessive focus on growth and customer experience.

Enter Marketplace Lenders and their more “flexible” approach to credit risk assessment.

While much good has come from this evolution in financing, new challenges have surfaced – especially as it pertains to fraud prevention and credit risk management.

Stacking has emerged as a particularly knotty problem in the small business lending space. Applicants have the opportunity to apply for and be approved for multiple loans in a matter of days or even hours.   Technology allows for underwriting that is at least somewhat automated and depositing often occurs within hours of approval. The speed of fulfillment is a boon for small businesses. However, it also makes it possible to be approved and draw down funds on multiple loans in quick succession. Core underwriting metrics, such as debt-to-income ratios and cashflow, are unreliable in the face of ratcheting debt from concurrent online business loans.

This situation occurs because the window between the approval of the loan and delivery of the funds is much shorter than the timeframe to report the loan to credit reporting agencies and other third-party data suppliers. Not all lenders report small business loans, further compounding the problem.  Lenders’ risk and pricing strategies are hamstrung in the face of stacking, whether intentional on the part of the small business or not.

If a struggling small business applies for credit and receives multiple loan offers, should we rely on their ability to resist the temptation to accept them all and use the funds wisely? No. The burden rests squarely on the credit provider to proactively address the problem.

Technology-enabled frictionless underwriting underpins the online consumer loan space and facilitates a similar, yet subtly different stacking problem.  There are a large number of loan providers, with a spectrum of risk appetites and pricing strategies. This all but ensures that a consumer has access to additional loans at an ever-increasing interest rate. The underlying assumption, among the more mainstream, lower-rate providers, is that the consumer is disclosing all of their obligations – including any recent loans.  Although reporting in the consumer space is more robust and timely, it is still possible for an applicant to quickly access and draw funds on several loans within a very short timeframe, making it difficult for loan providers to get a full and complete picture of their capacity to repay the loan.

The situation is further complicated by lenders at the higher risk, higher rate end of the market whose business models are structured to allow for, and perhaps even encourage, stacking by the consumer.

Fortunately, there are a number of steps lenders can take to improve the situation:

  1. Contribute credit data to the credit reporting agencies.
  2. Know your customer, their industry, their market and underwrite appropriately.
  3. Develop a tailored underwriting approach that achieves a balance between frictionless customer experience and prudent credit and risk assessment. All applicants are not equal, and some require additional scrutiny and more time to underwrite.
  4. Understand the drivers and indicators of stacking.

The latter point is worth emphasizing. The time to address stacking is prior to funding. This requires the lender to anticipate, identify and pre-empt stackers. There is no 100 percent foolproof remedy.  However, lenders can stack (pun-intended) the odds in their favor. For example, if an existing loan has a high balance and is delinquent, might that be an indicator of a propensity to stack? What if the business owner has applied for multiple loans, resulting in multiple inquiries, over a 45-day period?

A proactive, data-driven anti-stacking strategy can yield positive results, reducing delinquency and losses. In combination with consistent comprehensive reporting to the bureaus, it can go a long way toward reducing the risk posed by this largely invisible threat.