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alternative lending

The financial world is buzzing with the new alternative lenders that are transforming the world of finance. But as an accountant who works with companies that have financing issues, this so-called "fintech" boom worries me.

Financial technology (fintech) is a rapidly expanding industry. And profitable – experiencing exponential growth in investment from $3-billion in 2013 to $6.8-billion in 2014. It is comprised of companies that use technology to make financial systems more efficient. Fintech embodies a new set of innovated products that are tailored to the unique needs of small businesses. These include marketplace (peer-to-peer) lending, merchant and e-commerce, invoicing, online supply-chain finance and online trade.

The fintech industry caters to businesses that provide supply-chain financing as well as alternative-financing models to small businesses and consumers. The alternative lending space has grown rapidly in Canada thanks in part to the success seen in the United States and in London. Companies are now aiming to offer financing arrangements at competitive rates to small businesses and consumers. Some even offer financing to consumers that will allow them to pay off credit cards.

A majority of players within the fintech sector thrive due to the ease and quick accessibility of these loans. Unlike banks, where rigorous and diligent credit checks take days or weeks to approve loans, these start-up ventures shorten their turnaround time by merging technology, social media, statistics and complex algorithms to expedite the loan-approval process. Some of these start-up ventures approve loans within minutes, with funds showing up in your bank account by the end of the day. But these different approaches to check credit worthiness are problematic. Loans may be offered to small businesses or consumers who are not well suited for this type of financing due to their inadequate credit history.

There are risks on a micro and macro level, too. Potential funding to unfit borrowers combined with the systemic risk of a partially unregulated sector could have a negative impact on the financial markets in the future.

During The Future of Lending Now event held at the Mars Centre last month, Kevin Sandhu, CEO of Grow Financial (previously Grouplend) stressed that federal regulation has not caught up to the innovative practices within the fintech sector.

These smaller loans may be unsecured, meaning that only the borrowers' creditworthiness supports the loan rather than hard collateral. This opens the floodgates to increased risk of fraud and more personal and business bankruptcies.

While StatsCan reports that business bankruptcies have fallen 0.7 per cent in the third quarter of 2015 compared with the same quarter the previous year, that could change. With the increasing amount of alternative financing available, this number could be higher in the future.

Alternative financing isn't new: In the 2008 U.S. credit crisis, the majority of bad debt stemmed from mortgage dealers who issued loans to individuals who were not financially capable of obtaining a regular loan. Although mortgages differ from small-business loans, the worrisome premise remains the same – unqualified individuals and small businesses may be receiving funds that they would not otherwise be qualified to receive.

Alternative financing may offer fast money to consumers and small-business owners, but it's consumers, suppliers and employees who suffer when a business fails.

Talib Contractor is a Chartered Professional Accountant and senior analyst at Collins Barrow in Toronto.

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