By Peter Rudegeair, Emily Glazer, and Ruth Simon

J.P. Morgan Chase & Co. spent about $8 billion this year on technology. But when it came to developing a new online loan for small business, the bank turned to an unlikely outsider.

Early next year, J.P. Morgan will start using online lender On Deck Capital Inc. to help make loans to some of the bank’s roughly four million small-business customers. On Deck Capital, which has extended as much credit in its eight-year history as J.P. Morgan does in a few months, will help the bank process applications more inexpensively and quickly, in hours instead of weeks.

The partnership offers considerable upside for both parties, while also highlighting some of the risks that banks must consider as they weigh whether to team up or compete with fast-expanding online lenders.

The unexpected deal came together this month because the nation’s largest bank by assets wants to improve its game in small business. In April, J.P. Morgan Chief Executive James Dimon flagged the area as one in which the company could increase its market share, currently about 8%. The bank lags behind rivals Bank of AmericaCorp. and Wells Fargo & Co., according to Barlow Research Associates, a Minneapolis consulting firm.

There is more than revenue at stake: Lending more to small businesses also could quiet critics that have said banks don’t do enough to help the economy. Together, 10 of the largest banks issuing small loans to businesses lent $44.7 billion in 2014, down 38% from a peak of $72.5 billion in 2006, according to a recent analysis of the banks’ federal regulatory filings.

“This is something the big banks have neglected for a long period of time,” said Jared Hecht, CEO of Fundera Inc., a company that matches small-business borrowers with lenders. “They now want to participate.”

As part of the deal, OnDeck won’t put up any capital. Instead, the publicly traded New York firm will get fees to originate and service loans for J.P. Morgan, many with a value up to $250,000, previously considered too small to move the needle at the big bank. OnDeck also can use data it gleans from the partnership to improve its lending models.

“We think it’s a watershed partnership,” said OnDeck CEO Noah Breslow.

J.P. Morgan, meanwhile, is pushing to expand share with business clients who want smaller loans or need money for just a few months. Those loans can bring in double-digit yields, but also are expensive to make, which is why J.P. Morgan and other banks often steer these customers to a credit card.

The bank declined to disclose details about its default rate or pricing.

J.P. Morgan extended $1.7 billion in business banking loans in the third quarter, up 4% from the same period a year ago. In the same period, OnDeck’s new-loan volume increased 54%, to $483 million.

OnDeck’s loans are typically more expensive than what a bank would charge, but the firm said it offers credit to businesses that don’t always qualify for bank loans. Annual percentage rates on OnDeck’s small-business loans stand at 43% on average, down from 66% in 2013. The average duration of the loans, which are secured mainly by a general claim on the business’s assets, is about a year. Loans in the J.P. Morgan partnership will last six, nine and 12 months, a person familiar with the matter said.

In comparison, the average annual percentage rate on banks’ business credit cards, which have become the default loan source for many small firms, averaged 13% at the end of December, according to

To the J.P. Morgan customer, OnDeck will be invisible. J.P. Morgan is keeping its new partner’s name off the venture, and the smaller lender will be prevented from pitching its loans to borrowers that J.P. Morgan rejects.

The bank decided to limit the partnership in part because some of the online firm’s business practices have drawn criticism from fair-lending groups, according to people familiar with the matter. This summer, OnDeck was among firms that didn’t sign a “bill of rights” that a coalition of nonprofits and online lenders released to promote transparent lending terms.

“I was very disappointed to learn that Chase plans to partner with OnDeck,” Dory Rand, president of Chicago-based research organization Woodstock Institute, wrote to the bank in an email reviewed by The Wall Street Journal. “We have heard horror stories about small business owners getting ripped off by high-cost OnDeck loans.” Ms. Rand’s organization promotes fair lending for poorer borrowers and is backed by banks including J.P. Morgan and groups such as the Ford Foundation.

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