Small Business Lending Options Expand via PayPal and Square

The research arm of the newly established site Business Insider, BI Intelligence, has released a report on current developments resulting from PayPal and Square’s recent entry into the small business lending space. The report, titled “The Small Business Lending Opportunity,” tracks how non-banking institutions have moved into this market due to a steep decline in traditional banks lending to small businesses, particularly those that boast less than $1 million in annual sales. Here are some of the main metrics referenced in this report.

The number of small business loans originated to small businesses in the U.S. has dropped substantially. This is particularly for those businesses with less than a million in revenue (as stated above). In 2003, loans to small businesses in this group hovered around 3 million, peaking at around 5.2 million in 2007 and dropping to 2.4 million in 2013. According to the report, this is due to financial institutions stricter lending requirements coupled with higher regulatory compliance costs. This means that small loans are no longer profitable to banks.
Over the past year, small business lending volume by PayPal and Square has risen substantially. Since these companies have less regulatory oversight and compliance requirements, they are able to serve this market profitably. From October 2013 to November 2014, PayPal’s estimated lending volume grew exponentially from $5 million to around $40 million. Square’s growth expanded from zero lending activity in February 2014 to just over $15 million in November 2014.
However, non-bank sources of loan money are typically expensive, and these costs need to be factored in to any loan decision. In fact, a chart that was included in the study demonstrates that PayPal’s merchant advances have a 25 percent effective interest rate. While more money is available from sources like PayPal and Square due to looser lending requirements, and the application process is generally quick and easy, it’s important to be aware that some of this is made up for in higher fees and interest.

It’s projected that many more non-banks will be entering the loan services industry over the next couple of years given the current state of the financial services industry. Since non-banks don’t need to adhere to the same regulations, there is a strong opening in this market, and it’s expected that these companies will take full advantage of this.