PayPal swoops into lending markets that banks abandoned

PayPal contends there is a correlation between where it's finding customers for its small business capital program and where banks have less of a presence on the ground. 

Fifty-four percent of the total value of PayPal Working Capital and PayPal Business Loan originations went to small businesses in ZIP codes where 10 or more branches closed between 2017 and 2021, according to data that PayPal shared with American Banker. 

Bank branch data is informing PayPal's lending, payments and financial services strategy in underserved areas, where it plans to expand financial products as bank branches close. It's betting that trend will continue following the bank crisis earlier this year.

"There is a gap for small business lending, which has become even more difficult as banks reduce branches across the U.S.," said Bernardo Martinez, vice president of microbusiness at PayPal. "We have found that most of our loans are going to areas after there have been branch closures." 

Additionally, more than 66% of PayPal's loans in 2022 went to low- and middle-income areas; and about 33% of the loans in 2022 went to small businesses in communities with a greater than 50% minority population. 

PayPal's loans are based on future payment flows, which are also used to collect repayments. The collection of more data has enabled PayPal to increase how much it lends, Martinez said. 

PayPal's average loan size increased during the past five years to $42,000, from $28,000, and the company has lent a total of $25 billion to small businesses worldwide since 2014. PayPal did not release U.S.-specific yearly volumes for 2017-2021.

Buoyed by the numbers, PayPal plans to push open-banking technology in these communities. Open banking is the process of sharing financial data to enable a bank or payment account to be used to access products from third parties. This will give PayPal an opportunity to expand its relationships with businesses in these communities, Martinez said.

PayPal is part of a market of payment-oriented fintechs that offer loans on top of payment processing to small businesses. These fintechs have long attempted to outflank community and regional banks by offering faster digital approvals based on the merchants' existing payment track record.

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The overall weakness in the banking sector that followed the collapse of Silicon Valley Bank earlier this year has drawn fresh attention to this model, given the potential for community and regional banks to reduce small-business lending.

During American Express' most recent earnings report, CEO Steve Squeri said the company is looking for an opportunity to expand small-business lending amid the banking slowdown. Amex provides financial services to small businesses via American Express Business Blueprint, which stems from its acquisition of the fintech Kabbage in 2020. Amex also introduced several payment products this year that are geared toward small businesses. 

"It's too early to know in detail, but there will be some contraction from banks in these communities because of the economic slowdown," Martinez said, adding there is a chance to get more aggressive. "We are taking action in these communities." 

In addition to banks, PayPal competes with Block and Stripe to extend credit to small businesses. Block, which did not comment for this article, has a merchant lending program similar to PayPal's, and also has an industrial bank license. PayPal's small business lending is managed by WebBank, a Utah-based financial institution. 

"We built charge card capabilities for Stripe Issuing because it was one of the most requested features from our Issuing users," said Denise Ho, head of product for banking-as-a-service at Stripe, in an email. "While we continue to provide reliable payments infrastructure to our users, it's also important to be their one-stop-shop for other financial needs that the businesses or their customers have."

PayPal and its rivals may be targeting areas previously served by community banks, but large banks have also been deemphasizing branches. Bank branches in general have had a net decline from more than 100,000 in 2009 to about 80,000 in 2022. And Self Financial reports that branches are closing at a rate that will leave fewer than 16,000 branches by 2030 and no branches by 2034.

Branch closures have disproportionately impacted low-income communities. One third of the branches that closed between 2017 and 2021 were in lower-income and majority-minority communities, according to the National Community Reinvestment Coalition. 

"It appears that branch closures in lower-income areas have been driven mainly by large banks, not regional and community banks," said Aaron McPherson, a principal at AFM Consulting. "The pandemic seems to have accelerated this activity." 

But there's not necessarily a bank branch desert, so the fintechs aren't moving in unopposed. McPherson referenced a report from the American Bankers Association that found a typical resident of a low-income census tract lives within two miles of 17 bank branches. 

"Of course there has been a lot of consolidation among regional banks that may be contributing to branch closures," McPherson said, adding that differences in underwriting could also contribute to a lending gap between banks and fintechs in these communities.