There is a growing payments trend happening affecting customers and merchants in eCommerce. Instead of using credit cards to pay for purchases, a new payment option is quickly gaining popularity: alternative financing.
Currently, there are two common sources of alternative financing: third-party financial institutions and marketplace lenders.
Third-Party Financial Institutions
Payment companies such as PayPal, Amazon, and Affirm have partnered with third-party banks to provide instant loan services to online customers. Either the payment company or the third-party bank carries out credit checks to determine the customer’s credit worthiness. In the case of PayPal, a fixed credit line is established that can be adjusted based on purchases made, pending approval. Instead of FICO credit scores, Affirm calculates the risk and sets the rate and structure for borrowers based on information from their social media accounts and the cost of items they want to purchase. Amazon offers both pay-in-full and revolving credit lines.
Kabbage is an innovative alternative to financing solutions provided by traditional financial institutions. Targeted at small businesses, the application for a loan from Kabbage is done entirely online. Instead of using only conventional credit reports, applicants are invited to connect their online service accounts so that their real-time business data can be included in the decision-making process. Business loan applications can be approved in just a few minutes.
Chinese eCommerce giant Alibaba has an e-Credit Line loan product by partnering with marketplace lenders including Lending Club, iwoca, and ezbob. Buyers in the U.S. can borrow up to $300,000 per purchase with available credit at competitive interest rates.
Bitbond is a marketplace lender that sets itself apart from most of its competitors by focusing on loans to online businesses, including Amazon and eBay sellers, using bitcoin. By using cryptocurrency, Bitbond aims to keep its transaction fees low and to appeal to a wide international market for both borrowers and lenders.
There are advantages and disadvantages when considering alternative financing, either as a borrower or a lender.
Easier access to loans
For many consumers, such as millennials, and small business owners still getting established, alternative financing can provide access to funds previously unavailable to them. Because non-traditional forms of determining credit worthiness are used, often in conjunction with credit reports, lenders can get a comprehensive financial footprint of a borrower that goes beyond credit history. As a result, alternative financing is seen by many as being more balanced and fair in terms of making loan decisions.
Lower interest rates
Because alternative lenders typically have access to a more comprehensive profile of borrowers, they can offer lower interest rates for loans compared to traditional financial institutions. Having more comprehensive information about the applicant helps manage risk, as lenders can more accurately determine the likelihood that someone will repay their loan.
Inadequate regulatory oversight
Alternative financing, especially marketplace lending, is not clearly regulated in many jurisdictions. Financial regulators are still catching up with financial technology (fintech) innovations in many areas, not the least of which include loans and cryptocurrency. As a result, there may be an increased risk of fraud losses for lenders if strict due diligence procedures are not consistently followed as with regulated financial institutions.
Higher risk of loss
Marketplace lending companies frequently advertise higher potential returns on investments in loans. As in all forms of investments, a higher potential return means a higher potential of monetary loss. In the case of alternative financing, because of the higher acceptance rate of loans approved for those who may be considered at higher risk of non-repayment by banks, there is a chance that investors may lose some or all of their capital. Marketplace lenders such as Lending Club make this point very clear on their website.
Both consumers and businesses alike are adopting alternative financing options in greater numbers than ever. It may seem like a win-win situation for some, but it is important to weigh the pros and cons. Certainly, there is much that could be gained by borrowers and lenders, as long as the necessary safeguards are put in place.
Do you think that alternative financing needs to be regulated?