Alternative Financing: What It Is and Why Banks Fear It
Alternative vs. Traditional Finance
Common Alternative Financing Examples
- Crowdfunding: Crowdfunding, in which large numbers of people contribute small amounts of money toward a specific project, can be based on donations, equity or rewards. Reward-based crowdfunding, the second largest category of alternative financing, provides backers a nonfinancial reward in exchange for funds.
- Peer-to-Peer Lending: Groups of individuals support a business venture by providing unsecured personal loans in exchange for a return on that investment over time. It’s the largest category of alternative financing.
- Microfunding: Small amounts of money are loaned to small businesses or entrepreneurs, often in economically disadvantaged areas. These sums are significantly smaller than the minimum banks will fund.
Scope of Alternative Financing
- In 2015, the market volume in the Americas jumped from $11.4 billion to $36.49 billion, with $36.17 billion of that volume in the United States alone.
- Use of alternative finance methods in North and South America increased from 2014 to 2015 by 212 percent.
- In a two-year period, online alternative finance platforms provided more than $10.8 billion worth of capital to over 268,000 small businesses and startups in the United States.
Factors Influencing the Rise of Alternative Finance
Factors contributing to the rising use of alternative finance options include the economic crisis that occurred around 2008 and an ever-advancing level of technology. Specifically:
- After the recession that followed the housing market meltdown, small business owners find obtaining credit or capital even more challenging, as banks apply more stringent criteria and favor large companies and large loans. Banks deny more than 80 percent of small business loan applications.
- Technological advances extend to the finance world, too. Emerging technological innovations in the financial sector, dubbed “FinTech,” allow for online collection of information, near-instant analysis of lending criteria and extremely fast authorizations, credit checks and financing approval. FinTech also connects crowdfunding platforms to people across the world and expands the network of peer-to-peer financing sources, rapidly and easily connecting those in need of money with those wishing to invest.
Alternative finance companies threaten the traditional banks’ business models, as well as their market volume. As world technologies and consumer expectations continue to evolve, so must the banking industry.