Funding, Fintech and the Fed: A Small Business Owner's Guide to Rate Hikes

Given the Fed’s recent rate increase and three more increases expected this year, the lending space -- especially as it relates to small business -- will likely see some changes.

On the most surface level, some factors are easy enough to anticipate. For example, rates on small business loans are expected to rise. In that same vein, it’s not unreasonable to expect higher costs of operation for small businesses, stemming from similarly rising rates on things like real estate and vehicles that are needed to carry out day-to-day business tasks.

Interest rates also impact more than the cost of running a business -- often, they signal a change in the behavior of the consumers that small businesses rely on most. The final weeks of 2016 reflected a strong economy and stock market. Although these prospective customers will be dealing with rising rates on their own -- particularly in the form of car, credit card and mortgage payments -- economic strength is a good sign for consumer optimism and increased spending. In the long run, business owners can profit off greater volume created as a result of the positive buying sentiment.

It’s also important to keep in mind that small business does not exist in a vacuum. In many ways, small businesses are a central influencing factor on the entire United States economy, and are tied closely to other institutions. In 2013, there were 28.8 million small businesses in the United States. Small businesses comprise 99.9 percent of all firms in the U.S. economy. As of the SBA’s July 2016 Small Business Finance report, 73 percent of small firms had used financing in the last 12 months. According to the same report, bank loans going to small businesses totaled almost $600 billion in 2015.

Following the December 2016 rate hike and looking ahead to the future, there are two sectors that small business owners should keep a close eye on:

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Banks

In recent years, many banks have pulled out of the small business lending space because, without sufficient profit margins on these smaller loans, lending was not profitable. As rates rise, however, small business owners should look to these banks to make a reappearance in the small business lending scene.

With higher rates, banks may be willing to take on more risk than before and see better returns as a result. Technology also plays a factor in the banks' reemergence into the lending scene. It’s easy to remember banks of the past as conservative, slow-paced and bringing a wave of paperwork in their wake. However, the 21st century, with all its technological advancements, is starting to affect the banking industry as much as any other, and is changing the lending process greatly. Automation is now enabling banks to re-enter the small business loan market profitably, efficiently and in a compliant manner.

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Marketplace lenders

Speaking of technology that has changed the face of the lending industry, the rise of fintech-driven alternative lenders is one of the driving forces actively reshaping small business lending. Despite much higher rates than traditional banks, their ability to create a streamlined process online has garnered them success in the current market.

However, with more banks looking to return to the sector, many of these alternative lenders will face tougher competition. By continuing to charge higher rates due to a higher cost of capital, they may struggle to remain competitive as lower monthly payments from banks may outweigh the value marketplace lenders bring to businesses. Additionally, with rates and defaults on the rise, the cost of capital for alternative lenders will increase potentially widening this pricing gap with banks.

Looking to the future

As with anything related to starting or running a small business, it’s necessary to look at things over the longer term. With rates expected to continue rising throughout the year, the foundation of small business lending is changing. Market dynamics will force alternative lenders and banks to evolve to best meet small business customer needs.

One solution may be for alternative lenders and banks to partner together to ensure business needs for capital are met. This combination can result in the best of both worlds; low bank interest rates as well as alternative lending speed, user experience and approval rates. And by choosing a financing solution that melds a bank and fintech partnership, small business owners can set themselves up for success in our rapidly changing economy.