When the Federal Reserve increased interest rates on December 16th, 2015, borrowers and alternative lenders might have felt a twinge of unease. After all, investors who’ve been funding these lenders can now earn a higher rate through traditional banks.
So just what are the effects of rising interest rates on alternative lending? Will investors and big banks celebrate rising interest rates while alternative lenders and borrowers worry about going out of business? Not necessarily. When it comes to alternative lending, rising interest rates have a silver lining.
Though the first rate increase in 10 years is a small one, it likely signals a rising interest rate trend. And paying more to borrow money sounds like bad news to small business owners who need a loan now, as well as to the alternative lenders who’ve been supplying these loans for the past few years.
As rates go up, banks are eager to lend more money—because they’ll make more money. Accordingly, they might relax their lending requirements.
This effect of rising interest rates could appeal to a borrower for several reasons.
As interest rates increase and banks lend more to previously unqualified small businesses, alternative lenders will have to start focusing and fine-tuning their ideal customer profile instead of simply offering loans to higher risk borrowers. This effect of rising interest rates could actually be good news for both alternative lenders and borrowers, because it will encourage lenders to get very specific about who they’ll best serve. As advances in technology promote and simplify the analysis of big data, these lenders will be able to efficiently review market and client demographics. Analytics will help them target specific groups of business owners.
As traditional bank-offered business lending becomes more competitive because of rising interest rates, alternative lenders will need to offer something unique to keep existing clients and attract new ones. This might mean developing customized products or services for certain sectors or industries—like e-commerce, artisan, or technology businesses—that big banks simply don’t have the time or interest in rolling out.
When borrowers get what they need from their traditional lender, they’ll need a pretty compelling reason to look for a different source of credit. In order to maintain and grow their market share, alternative lenders will have to do an even better job of branding themselves as unique and modern.
While increasing interest rates may whet the appetite of big banks when it comes to lending to small businesses, the banks are also very aware that there’s a demand for alternative lending in the form of online loans—and they want a piece of the action. The most notable example might be J.P. Morgan Chase & Co.’s agreement with OnDeck Capital to develop an online small business loan product for its small business customers. Don’t be surprised if the effects of rising interest rates also include the business world hearing of more of these arrangements between the country’s biggest financial institutions and the major players in the alternative lending markets.
Increasing interest rates affect not just those looking to borrow money, but also those who have money to invest.
Some individual private investors may feel they’ll get a better bang for their buck, and less risk with savings accounts and certificates of deposit, as the rates creep up. But venture capitalists who see the potential in innovative alternative lending platforms will continue to be drawn to this opportunity. And there will always be forward-thinking individual investors, including business social investors, who like the idea of giving their aspiring business peers financial help.
The effects of rising interest rates, improvements in Fintech, and changing customer demand will influence the world of alternative lending in ways we can’t even predict. Will the big banks swallow up alternative lenders completely, and will investors abandon alternative lenders for the security of traditional fixed income offerings?
Probably not. As long as there are independent-thinking business owners and investors who want to operate outside traditional funding parameters, there will be a place for alternative lenders. And as these lenders compete for investment funds and client businesses, they’ll simply have to improve to stay in the game. And that’s good news for small business owners.