A new study from the Goizueta Business School at Emory University shows FinTech may be a strong option for small business customers of large and out-of-market banks. The findings of the study illustrate how FinTech small business lenders have grown more rapidly in areas with higher prevalence of large/out-of-market banks. That’s likely because of FinTech advantages in processing of hard information such as financial statement ratios and more general business data.
FinTech refers to firms that use information and financial technologies to provide financial services, often in competition with traditional banks. Globally, FinTech investments are booming, and FinTech small business lending is one of the fastest growing FinTech segments. It is important to understand what is fueling this growth to prepare for the potential disruptions to come.
The study by Professor Tetyana Balyuk from the Goizueta Business School and Professors Allen N. Berger and John Hackney from the University of South Carolina --- in partnership with Funding Circle --- find that FinTech tends to replace small business loans by large/out-of-market banks more than by small/in-market banks. The study looks at data on FinTech penetration in small business lending and the presence and small business lending of banks for over 3,000 U.S. counties over a 13-year period.
“Our study shows that FinTech small business lenders grow more rapidly in areas with greater presence of big banks and in areas where big banks have higher small business loan volume,” says Goizueta’s Tetyana Balyuk. “We believe that this is due to FinTech firms’ competitive advantages in more efficient processing of hard information, rather than in hardening of soft information.”
Balyuk adds: “By counteracting reductions in bank credit supply, FinTech lending may provide broad economic benefits to the public, especially small businesses. This could be a key to small business success in communities underserved by traditional banks.”
The findings show three main reasons why small businesses in markets with greater prevalence of large and out-of-market banks may switch to FinTech loans:
Large banks use similar technology and process the same type of information as FinTech lending platforms. However, small businesses may find that dealing with large banks to be slower and more cumbersome.
Small businesses are less likely to have strong banking relationships with large and out-of-market banks because these banks are traditionally not relationship lenders. Thus, small business customers of these banks may find it easier to switch to FinTech lenders.
Small businesses that borrow from large banks traditionally receive less funding.
The hard-information technologies of machine learning and screening algorithms using big data and alternative data are key parts of FinTech’s differentiation and success. FinTech lending platforms use algorithms to automate the decision-making process and provide faster credit decisions at a possibly lower cost. FinTech loans may be riskier than bank loans, as these lenders extend credit access to the riskiest small businesses. Nonetheless, the study suggests that FinTech loans may become safer after replacing bank loans. FinTech is also found to have positive effects on the economy by boosting hiring by small businesses with fewer than 50 employees.
FinTech growth in small business lending in the U.S. is in sharp contrast to the significant decline in bank lending to small businesses after the Global Financial Crisis that likely resulted from increased regulatory burden on banks after the Dodd-Frank Act (e.g., through stress test exposures). This long-term reduction in the supply of traditional bank credit to small businesses may be one reason why 20 percent of all small businesses have sought financing with a FinTech lender.
The study shows that FinTech lending can indeed mitigate reductions in large/out-of-market lending and have positive real effects for smallest businesses. The FinTech support of small businesses is important because these businesses are responsible for the majority of America’s job growth and half of the U.S. GDP.