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Are Banks Really Losing Business to Fintech Lenders?

A recent academic study titled Fintech Borrowers: Lax-Screening or Cream-Skimming? set out to address two questions:

  1. Did fintech lenders ease credit access for borrowers underserved by the traditional banking industry or are they selecting the best borrowers?
  2. Are borrowers able to lower their financing costs and improve their credit outcomes through a personal loan by a fintech lender?

The study used a data source that provided detailed information about borrowers’ credit histories and lenders’ identities. The authors found:

  • Fintech borrowers are on average younger, they earn more, live in higher income neighborhoods and are more likely to be professionals--dispelling the notion that fintech lenders target borrowers that have been credit rationed by traditional banks.
  • In the first six months after origination, fintech borrowers’ credit outcomes improve; however, in the following twelve months, they are significantly more likely to be delinquent, have higher revolving balance and a lower FICO score.
  • While fintech borrowers are more creditworthy based on ex-ante observables, they are also more likely to be present-biased, i.e., they are more likely to carry a significant credit card balance and less likely to use the loan to consolidate their high-cost debts.

Overall, these findings suggest that fintech lenders enable households with a particular desire for immediate consumption to finance their expenses.

Fintechs and Small Businesses

Interestingly, there is a similar pattern on the small business lending side of the coin. In a study titled Nonbank Lending, the authors concluded:

"Smaller, unprofitable, R&D-intensive firms with high stock volatility are significantly more likely to borrow from non-banks. Overall, our results provide evidence of market segmentation in the commercial loan market, where bank and non-bank lenders utilize different lending techniques and cater to different types of borrowers."

Fintechs and Mortgages

Those conclusions (regarding the small business lending market) are echoed by researchers from the four most-prestigious business schools in the country (including, of course, my alma mater the University of Texas at Austin). In Fintech, Regulatory Arbitrage, and the Rise of Shadow Banks, the researchers looked at "shadow banks" (non-banks, including fintechs) and found that:

"Fintechs possess better technology. By using big data and different models, fintechs are able to charge significant premium versus non-fintech, suggesting they provide convenience rather than cost savings. However, fintechs do not democratize credit access, and do not appear to reduce cost of credit."

The banking press and blogosphere rants and raves about the (alleged) market share gains of non-banks--and fintechs in particular--in the lending markets but miss what's really going on here: Fintechs are lending to borrowers that banks don't want to lend to.

I say "alleged" market share gain because the reality may be that fintechs are expanding the market for loans, not cannibalizing existing bank loan volume. And with the rise on non-bank lending in the mortgage underway for a number of years already, the fintechs' gain may actually be taking business from the non-banks, not the banks themselves.

Pundits point to the market share gains of fintechs as evidence of the death (or at least decline) of banks. There's another narrative, here: Banks' superior underwriting capability is helping them win good business, not just any business (just look at the growing default rates at the marketplace lending sites). As I'm fond of saying, anyone can lend money--getting it back is the hard part. The first step in "getting it back" is knowing who to lend it to in the first place.

The Trust Factor

Banks may have one more trick up their sleeve, however: Trust. In a study titled Trust in Lending, professors Richard Thakor and Robert Merton state:

"Trust enables lenders to have access to financing at rates that are insulated from the adverse reputational consequences of prior loan defaults as well as market conditions. [Trust] is most likely to be eroded when the lender experiences relatively high borrower defaults during an economic boom."

That's exactly what's happening now as fintechs are seeing higher default rates. The professors go on to say:

"From a functional perspective, banks and fintech platforms perform similar lending functions. Our analysis of trust and a characterization of the difference between banks and fintech lenders relies on an essential institutional difference between these lenders|banks have access to insured deposits and they provide valuable depository services to their customers, whereas fintech platforms are entirely investor-financed. This distinction makes banks innately more trustworthy than fintech platforms, and provides them with a competitive advantage over non-depository lenders on the trust dimension."

The Role of Technology and Data

Banks shouldn't get complacent, however. A consistent theme throughout the academic research was the advanced use of technology and data on the part of fintechs. While this has not necessarily translated into them winning "better" business (yet, at least), it has allowed them to win business faster and cheaper. And that's the future threat to banks. In the race "to the top," the banks have a head start (by starting off in the middle of the mountain), but the fintechs may have the technology and data to catch up.

Ron Shevlin
Director of Research
Cornerstone Advisors

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