The Bank for International Settlements (BIS) published a paper that studies impact of fintech lending on credit access for small businesses in U.S. The paper explores the capacity of fintech firms to facilitate access to credit for small business owners that are headquartered in less financially developed areas and assesses the performance of such loans.
The paper compares small business lending by fintech firms with such lending by traditional lenders in terms of interest rates and loan maturities. The paper examines whether fintech lenders have enhanced credit access to small businesses, which are likely to be underserved by traditional lenders. It also looks at the measurable differences in the information content in credit scores assigned by fintech lenders vs the traditional credit rating agencies and assesses the added value of alternative data in credit risk evaluation and lending decisions. The paper analyzed proprietary loan-level (CCAR monthly submission) data from two fintech small business lending platforms (Funding Circle and LendingClub) to explore the characteristics of loans originated pre-pandemic over the period 2016-2019. Funding Circle and LendingClub are examples of large fintech lenders that use big data and complex machine learning algorithms to evaluate the credit risk of small businesses and that of the business owners and to make lending decisions at a much faster speed than traditional lenders. The findings show that:
- fintech lenders can serve borrowers who were less likely to receive credit from traditional banks and that they employ alternative data to improve their credit risk evaluation and scoring.
- fintech small business lending platforms lent more in zip codes with higher unemployment rates and higher business bankruptcy filings.
- internal credit scores of fintech platforms were able to predict future loan performance more accurately than the traditional approach to credit scoring (that is, the business owner’s credit rating by FICO or Vantage scores).
- the divergence of fintech scores from traditional credit scores and the improvement in predicting credit delinquencies were particularly stronger in areas with high unemployment rate.
- fintech lenders provide credit to additional small business borrowers at lower cost.
The paper notes that, while offering similar loan products as banks, fintech lenders have been subject to a different set of regulations. All consumer loans from banks and nonbanks are generally subject to some consumer protection laws, but nonbank lenders are not subject to the periodic onsite examinations to which the banks are subject. However, through recent partnerships with banks, some fintech platforms have also been subject to examination (as a significant banking service provider) or are indirectly subject to the rigorous standards that banks must comply with. Several fintech platforms have recently become a bank either through acquisition or are being granted a banking charter, allowing them to access low-cost funding through insured deposits. Banks have also been investing and partnering with fintech vendors to access today’s technology. Over time, bank loans and fintech loans are likely to become more alike as this trend continues.
The paper concludes that fintech lenders have been able to expand credit access to the underserved small business owners that are not likely to receive funding from traditional lenders. The paper notes that fintech partnerships with community banks during the pandemic made it possible for partnered banks to reach new customers, allowing small banks as a group to originate a larger share of PPP loans than their share of banking assets. As collaborations and partnerships grow, the traditional banks and fintech firms would become more efficient in utilizing borrower data.
Keywords: International, Banking, Lending, Credit Risk, Fintech, Non Bank Financial Institutions, Credit Scoring, SME Lending, Regtech, P2P Lending, BIS
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