Over the past decade and a half, since the 2008 financial crisis, the United States has seen unprecedented growth of technology in the lending process. It has reached the point where some lenders now rely solely on the financial technology (FinTech) to make lending decisions.
Traditionally, banks have relied on credit scores from agencies like FICO to make lending decisions – a time-consuming process requiring extensive paperwork and in-person meetings – that is less accessible for many borrowers.
In the recent years, FinTech companies, like SoFi and LendingClub, use advanced technologies such as artificial intelligence (AI) and big data analytics to assess creditworthiness. These technologies analyze a wide range of data points, including social media activity, online transaction history and even utility payments, to make more informed lending decisions quickly.
To better understand how FinTech has impacted the business loan market, Konstantinos Serfes, PhD, a professor of economics in the LeBow College of Business, developed a theoretical model to compare FinTech with traditional bank lending practices. The study, “FinTech vs. Bank: The Impact of Lending Technology on Credit Market Competition,” was recently published in the Journal of Banking & Finance.
In an interview with the Drexel News Blog, Serfes shared how this technology is transforming lending; how his model can be applied to compare other loans — beyond those for small businesses; and the advantages and disadvantages of both FinTech and traditional bank loans.
What is the biggest takeaway from your research?
One key aspect of the research is the role of technology in transforming the lending landscape. The study emphasizes that advancements in screening technology can significantly impact credit supply and interest rates. At the same time, it acknowledges the limits of screening technology in evaluating long term risks. It also highlights the importance of regulatory oversight to ensure that the growing role of FinTech lenders does not lead to systemic risks in the financial system.
How is FinTech impacting the financial sector and lending?
The conclusion that FinTech lenders primarily supply unsecured loans to borrowers with short-term projects, while traditional lenders focus on asset-backed loans for long-term projects, has several implications:
- Market Segmentation: This differentiation allows both types of lenders to coexist without direct competition, leading to a more segmented and specialized credit market.
- Credit Accessibility: Small businesses and startups with short-term funding needs and limited collateral can access credit more easily through FinTech lenders.
- Risk Management: Because of their collateral underwriting and management capacities, traditional lenders can manage long-term loans risks better than FinTechs.
- Regulatory Focus: Regulators may need to adapt their frameworks to address the unique risks and benefits associated with both types of lending.
Can you explain the model used in your research?
Imagine two types of lenders: FinTech and traditional banks. FinTech lenders use advanced technology to evaluate borrowers quickly and offer loans without requiring collateral. They focus on short-term loans, which are typically needed for immediate, smaller-scale projects. Traditional banks, on the other hand, rely on physical assets as collateral and take longer to evaluate borrowers. They prefer long-term loans, which are used for investment projects.
The model shows how these two types of lenders can coexist by serving different segments of the market based on their strengths.
Can this model be applied to other types of loans, like personal loans?
Yes, the model can be applied to other types of loans, such as personal loans. For example:
- Personal Loans: FinTech lenders might offer quick, unsecured personal loans for short-term needs like medical emergencies or home repairs. Traditional banks might offer secured personal loans for long-term needs like home renovations or education, where the borrower can provide collateral.
- Mortgage Loans: FinTech lenders could focus on refinancing existing mortgages, which can be automated and require less collateral underwriting. Traditional banks might focus on new home purchase loans, which involve more extensive collateral underwriting.
Are there advantages or disadvantages to this type of lending?
There are both advantages and disadvantages to both FinTech and traditional bank loans.
The advantages of FinTech loans are:
- Speed and Convenience: Faster approval and disbursement processes.
- Accessibility: Easier access for borrowers with limited collateral.
- Flexibility: Often more flexible terms and conditions.
The disadvantages of FinTech loans are:
- Higher Interest Rates: Typically, higher interest rates due to the unsecured nature of the loans.
- Limited Loan Amounts: Generally smaller loan amounts compared to traditional loans.
The advantages of Traditional Loans are:
- Lower Interest Rates: Generally lower interest rates due to the secured nature of the loans.
- Larger Loan Amounts: Ability to offer larger loan amounts due to collateral.
And the disadvantages of Traditional Loans are:
- Longer Approval Process: More time-consuming due to longer and less automated collateral underwriting process.
- Collateral Requirement: Requires borrowers to provide physical assets as collateral, which may not be feasible for everyone.
Why has this gained momentum in recent years?
There is access to more information. FinTech lenders can gather and analyze more diverse data, providing a more comprehensive view of a borrower’s financial health.
It’s a quicker process. The use of AI and automated systems allows for faster loan approvals, often within minutes, compared to the days or weeks it might take with traditional banks.
And it’s more flexible. FinTech lenders offer a variety of loan products tailored to different needs, such as short-term loans, peer-to-peer lending, and unsecured loans, making them more attractive to borrowers.
Reporters interested in speaking with Serfes should contact Annie Korp, assistant director, News and Media Relations, at 215-571-4244 or amk522@drexel.edu.
