Main Street Monthly: Understanding Online Lending

The Federal Reserve recently released the 2017 Small Business Credit Survey, which highlights small business credit experiences including loan approval rates, lending avenues, uses of funding, and more. Over 8,000 businesses across the United States with 1-499 employees were surveyed, and responses came from an array of industries, from professional services and real estate to leisure and hospitality. This article will emphasize the takeaways of the survey and point out the benefits and disadvantages of an emerging option for borrowers – online lending. 

The survey offers an optimistic update on employer firm performance, with 57 percent of firms operating at a profit and 53 percent of firms reporting an increase in revenue over the last 12 months. An impressive 72 percent of small businesses project that revenues will continue to increase during 2018. Since last year, the top financial challenge for small businesses has shifted from credit availability for expansion to paying operating expenses.* The survey shows a clear majority of firms facing these and other financial challenges resorted to the use of personal funds over taking out additional debt. 

Of the 60 percent of firms that did not apply for financing, only half of these reported having sufficient funding. The other half of non-applicants were either credit adverse or expected to be denied a business loan.* It comes as no surprise that the more access to capital a business holds, the more likely it is to generate profit and grow; however, for many small businesses, borrowing from large banks is not practical due to insufficient credit history and hesitation by large banks to spend resources funding a small loan that is expected to yield a small-scale profit. Therefore, an increasing portion of small businesses are turning to online lenders to bridge the gap in their finances. 

Self-identified high to moderate credit risk firms reported a 71 percent approval rating from online lenders for at least a portion of requested financing, compared to 45 percent from small banks, 35 percent from large banks, and 26 percent from credit unions. These online nonbank alternatives and marketplace lenders promise quick approval decisions and have more favorable collateral requirements.* This aligns with findings in Catalyzing Growth: Small Business Access to Capital, a report produced by BRAC in 2017, in which commercial lenders noted lack of collateral as the top issue found in unsuccessful applications in the Capital Region. 

The ease of submitting applications from the comfort of one’s own office or home has appealed to more Americans each year, with a reported 24 percent of small business loan applications filed online in 2017 compared to 21 percent in 2016.* However, it is important to note the costs that accompany faster underwriting processes and fewer eligibility requirements. Coupled with less favorable repayment options, the average annual interest rate charged by online lenders ranges from 13 to 71 percent. Compare these interest rates to those of small and regional banks, which range from 2.48 to 5.4 percent,** and it becomes apparent why borrower satisfaction with online lending is the lowest among all other avenues.   

Despite the drawbacks of acquiring funds online, Morgan Stanley estimates the online lending industry will grow at a 47 percent annualized rate through 2020.*** As brick-and-mortar institutions sense the progressive competition, experts suggest that the vitality of their small business lending programs relies on transition to digital banking tools and even partnership with non-bank entities.**** Cutting costs at every stage of the process through digitization gives the potential for small businesses lending to be more profitable, while partnership with online lenders surfaces opportunities to combine the distinct competitive advantages of both parties. However, the scope of an ideal partnership remains unclear for many banks as they consider which processes to contract out and how to remain compliant with federal oversight, which makes banks responsible for the activities of their vendors and partners. 

The Small Business Credit Survey and supplemental research reveal tradeoffs when deciding the optimal route to secure financing for a small business. Whether just getting off the ground or taking measures to keep an organization afloat, sufficient access to capital for small businesses acts as a backbone to a local economy’s ability to stimulate entrepreneurship. For insights about small business credit in the Capital Region and BRAC’s recommendations to accelerate growth, read Catalyzing Growth:  Small Business Access to Capital.   


*  “2017 Small Business Credit Survey:  Report on Employer Firms,” Federal Reserve of New York 2018, 

** “Average Small Business Loan Interest Rates in 2018:  Comparing Top Lenders” ValuePenguin Inc. 2018, 

*** “Global Marketplace Lending:  Disruptive Innovation in Financials”  Morgan Stanley 2015, 

**** Karen Gordon Mills, Brayden McCarthy. “How Banks Can Compete Against an Army of Fintech Startups”  Harvard Business Review 2017, 

Madison Costanza

As the economic research and policy intern, Madison is responsible for supporting a variety of projects and programs for the economic competitiveness team including monthly reports on economic trends.

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