FinRegLab: Cash-Flow Data is Increasing Access to Credit in Small Business Loan Markets

FinRegLab today issued an in-depth report analyzing the use of cash-flow data—variables and credit scores that are derived from bank account records and other sources—to increase lending to small businesses. The report, The Use of Cash-Flow Data in Underwriting Credit: Small Business Spotlight, can be found here.

The report finds that a range of fintech firms, traditional banks, and other market entrants are using electronic cash-flow data to speed processing times and reduce the costs of small business lending. The data has particular potential for helping startups and business owners that do not have strong traditional credit histories, but the report details a number of market and policy issues that may affect the pace and scope of its adoption going forward.

The small business analysis follows on an independent empirical study that FinRegLab published earlier this summer evaluating cash-flow variables and scores used by six non-bank financial services providers, including two companies that serve small businesses markets.

“Small business owners often struggle to access the credit that they need to operate and grow their businesses, particularly in the early years,” said FinRegLab CEO Melissa Koide. “This analysis suggests that a cash-flow data may be critical to helping small business lenders serve more of that market.”

Small businesses are the cornerstone of the U.S. economy, creating two out of every three net new jobs in the U.S. in the past fifteen years. But several factors make them relatively difficult and expensive to underwrite compared to consumers and larger companies. Businesses owned by racial minorities, recent immigrants, and women face particular challenges in accessing credit.

Over the last decade, both non-bank technology companies and traditional lenders have begun leveraging new data sources in an effort to reduce costs and improve accuracy in underwriting. Cash-flow information such as companies’ bank account records, feeds from their accounting software, and transaction information from e-commerce platforms and payment processors is at the core of these efforts.

Specifically, the report finds:

• Cash-flow data provides a more detailed, timely picture of small businesses’ income flows and cash reserves than traditional credit history information. Small business lenders have traditionally collected bank statements, cash-flow analyses, and other annual financial reports to help analyze the health of business applicants. But obtaining detailed electronic records allows lenders to engage in faster, more sophisticated, and more consistent analysis. The information is useful for established small businesses, but is even more valuable for startups and business owners who don’t have strong traditional credit histories.
• Use of cash-flow data appears to be spreading more rapidly in small business lending than in consumer lending. Use of electronic cash-flow data was pioneered by marketplace lenders after the 2008 financial crisis, but has since spread to a wide range of small business lenders. For example, a number of banks have begun analyzing their existing customers’ deposit data to facilitate faster underwriting. And payment processors, e-commerce platforms, and accounting software providers have begun using cash-flow data from their primary business operations to provide loans to small businesses.
• Further growth may depend on a number of market and policy issues. Such issues include technology and cost hurdles for small banks, data security and privacy considerations, and increasing investors’ and regulators’ confidence in the reliability of the data.

This report was made possible with support from the Milken Institute and its funders, The Rockefeller Foundation and JPMorgan Chase.

“Policymakers and financial institutions alike should take notice of what FinRegLab’s evidence-based analysis means for small businesses in the United States,” said Aron Betru, Managing Director at the Milken Institute Center for Financial Markets. “Relative to large firms, lenders’ insight into the creditworthiness of small businesses has always been limited. With access to cash-flow data, lenders can better understand small businesses and overcome this long-standing challenge.”

A forthcoming FinRegLab report will provide broader market context and policy analysis that bridges across consumer and small business markets. In particular, the report will provide a detailed description of market, legal, and policy issues raised by cash-flow based underwriting and by the underlying transfers of data between companies for credit and other purposes. The report builds on three working groups that FinRegLab convened in late 2018 to solicit insight and opinion from more than 80 representatives of fintech companies, banks, data aggregators, advocacy organizations, and research institutions.

FinRegLab’s earlier report was based on data from a range of non-bank financial services providers – Accion, Brigit, Kabbage, LendUp, Oportun, and Petal – that have begun using cash-flow variables and scores in an effort to provide unsecured credit to consumers and small businesses who may have difficulty obtaining loans from traditional sources. FinRegLab retained Charles River Associates to help design and conduct an independent analysis of the predictiveness of the participants’ cash-flow variables and scores based on actual loan performance.

FinRegLab was established with generous support from Flourish. Flourish also provided core support for FinRegLab’s evaluation of cash-flow data in consumer and small business credit underwriting and the earlier report, The Use of Cash-Flow Data in Underwriting Credit: Empirical Research Findings.