It is hard to borrow money for short periods of time. It is harder to borrow relatively small amounts of money for short periods of time. And that problem exists whether you are an individual or business, with just the definition of "small" changing.
To illustrate just how few options there are in the 'small short-term loans' market, let us run a search on one of the popular comparison search websites, MoneySuperMarket.com. If you want to borrow ten thousand pounds for a period of 5 years, there are as many as 42 options for a cost of just 4% APR in some cases. If however you want to borrow just one thousand pounds for six months, then there are just 3 options with the cheapest option being the peer-to-peer lender Ratesetter at 32.1% APR available only if you have an excellent credit score.
It is as difficult for a small business to get an affordable loan of £10,000 as it is for an individual to get one less than £1000. If you want a bridge loan for £500,000 secured by your property, then financial institutions and peer-to-peer lenders will fall over each other to lend to you. If you need only £20,000 there will often be no takers.
If you're a millionaire MD at Goldman Sachs with cash-flow problems, you can simply take a low-cost short-term loan against you collection of fine wines. On the other hand, a middle-class family with cash-flow problems may have to take out a 1000% APR loan from a payday lender and risk falling into a debt trap. As they say, it is expensive to be poor.
The primary reason for the shortage of affordable small loans is that most of these loans comes with significant transaction costs (manual processing, credit underwriting etc) which costs time and money. Therefore small, short-term loans are simply not worthwhile for most financial institutions. Unless of course they charge an usurious interest rate.
This is the reason why we have such an unequal society when it comes to access to credit. Large firms and rich individuals have financial institutions lining up to lend to them when they run into liquidity problems but the small business and the man on the street are forced into high-cost options such as payday loans or pawnbrokers with a cost of well over 100% APR. It is also the reason why high-cost lenders such as Wonga have flourished over the last half-decade by filling a hole in the market for small, short-term loans.
It is a well-established fact that expanding access to credit improves econoimc development. However, if the only credit accessible is expensive credit, then the benefits of access to credit come with the risk of falling into a crippling debt trap.
How can we solve this problem? In order to make affordable short-term loans available to the masses, we must reduce the cost of providing a loan through online lending, increased automation and replacing human judgement with algorithmic analysis. Only then can we provide a £500 loan for six months at an affordable interest rate.
As Marc Andreessen has argued, "disruptive innovation shrinks inequality, by bringing to lower-income consumers things that only richer consumers had access to before".
And online lending can provide small businesses and lower-income individuals with access to credit at terms that only large businesses and rich individuals have access to today.
