How Fintech Credit Can Change the Way We Borrow and Spend

If you have ever used an online platform to buy or sell goods, you may have noticed that some of them offer you the option to get a loan or pay in instalments. These are examples of fintech credit, a new form of lending that is enabled by digital technologies and big data.

Fintech credit is growing rapidly around the world, especially in countries like China, Korea, Malaysia, and Kenya, where it accounts for up to 5% of total credit.

But what is fintech credit exactly, and how does it differ from traditional bank credit? And more importantly, how does it affect the economy and the transmission of monetary policy?

In this blog post, we will answer these questions and more, using the insights from a recent study by the Bank for International Settlements (BIS).

What is fintech credit and how does it work?

Fintech credit is a broad term that encompasses various types of credit that are facilitated by online platforms and big data.

The most common forms of fintech credit are peer-to-peer (P2P) lending, marketplace lending, and big tech credit.

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P2P lending and marketplace lending are similar in that they both connect borrowers and lenders directly, without the intermediation of a traditional bank.

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The main difference is that P2P lending relies on individual investors, while marketplace lending involves institutional investors, such as hedge funds or banks.

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Big tech credit, on the other hand, is credit extended by large technology firms, such as Alibaba, Amazon, Facebook, or Mercado Libre, either directly or in partnership with financial institutions. These firms use their vast troves of data on their customers’ transactions, preferences, and behaviours to assess their creditworthiness and offer them loans.

Fintech credit has some advantages over traditional bank credit, especially for small and medium-sized enterprises (SMEs) and consumers who may face difficulties in accessing bank loans due to high costs, collateral requirements, or information asymmetries. Fintech credit can lower the barriers to entry and reduce the frictions in the credit market by:

Leveraging data and machine learning to improve the screening and monitoring of borrowers, and to tailor the loan terms and conditions to their specific needs and risks.
Offering faster, cheaper, and more convenient services, such as online applications, instant approvals, and flexible repayment options.
Exploiting network effects and switching costs to create customer loyalty and enforce loan repayment, by threatening to exclude defaulters from their ecosystems.
Operating under different regulatory frameworks, which may allow them to offer more competitive rates and fees, and to avoid some of the prudential rules and capital requirements that apply to banks.

How does fintech credit affect the economy and monetary policy?

Fintech credit can have significant implications for the economy and the transmission of monetary policy, which is the process by which central banks influence the level of interest rates, money supply, and credit conditions to achieve their objectives of price stability and economic growth. To understand how fintech credit affects monetary policy, we need to consider three main channels:

The interest rate channel: This is the most direct and traditional channel, by which changes in the policy rate affect the cost and availability of credit, and thereby influence the spending and saving decisions of households and firms. Fintech credit can weaken this channel, by making credit supply less sensitive to changes in the policy rate. This is because fintech lenders rely less on physical collateral, which tends to fluctuate with asset prices and monetary policy and rely more on data, which is less affected by monetary conditions. Moreover, fintech lenders can compete with banks and offer lower rates and fees, which can reduce the pass-through of policy rate changes to the lending rates.
The balance sheet channel: This is the channel by which changes in the policy rate affect the net worth and cash flow of borrowers and lenders, and thereby influence their ability and willingness to borrow and lend. Fintech credit can also weaken this channel, by making credit demand less sensitive to changes in the policy rate. This is because fintech borrowers tend to be less dependent on the value of their assets, such as real estate or financial investments, which tend to decline when monetary policy tightens. Instead, fintech borrowers rely more on their transaction volumes and network scores, which are more related to their business performance and general economic conditions.
The bank lending channel: This is the channel by which changes in the policy rate affect the balance sheets and profitability of banks, and thereby influence their credit supply. Fintech credit can have a mixed effect on this channel, depending on the degree of competition and complementarity between fintech and bank lending. On the one hand, fintech credit can intensify the competition and erode the market share and margins of banks, which can reduce their lending capacity and willingness. On the other hand, fintech credit can also create new opportunities and synergies for banks, such as partnering with fintech platforms, diversifying their funding sources, and expanding their customer base, which can increase their lending capacity and willingness.

What does the evidence say?

To test the empirical relevance of these channels, the study used a novel credit dataset that covers 19 countries from 2005 to 2020 and conducted a panel vector autoregression (PVAR) analysis, which is a statistical method that allows to measurement of the responses of fintech and bank credit to changes in the policy rate, while controlling for other macroeconomic variables. The main finding is that fintech credit shows a lower (and statistically non-significant) sensitivity to monetary policy shocks compared to bank credit. This result is consistent with a substitution effect between fintech and bank credit in response to a monetary tightening, as well as a limited impact of the collateral channel on fintech credit. it also finds that fintech credit contributes to less than 2% of the variability of real GDP, while bank credit accounts for about a quarter of it. This reflects the still marginal, although fast-growing, macroeconomic significance of fintech credit in most of the countries in the sample.

What are the implications and challenges?

The findings have some important implications and challenges for central banks and regulators. On the positive side, fintech credit can enhance financial inclusion, innovation, and efficiency, by providing more and better credit options to underserved segments of the economy, such as SMEs and consumers. Fintech credit can also mitigate the procyclicality of credit, by making it less dependent on asset prices and monetary conditions, and more responsive to business performance and economic fundamentals. On the negative side, fintech credit can pose some risks and uncertainties, such as:

Financial stability risks: Fintech credit can increase the complexity and opacity of the financial system, by creating new intermediaries, products, and channels that may not be subject to adequate regulation and supervision. Fintech credit can also increase the interconnectedness and contagion risks among different types of financial institutions, especially if there are large exposures or partnerships between fintech and bank lenders. Moreover, fintech credit can create new sources of systemic risk, such as cyberattacks, data breaches, or operational failures, which can undermine the trust and confidence in the financial system.
Monetary policy effectiveness: Fintech credit can reduce the transmission and impact of monetary policy, by making credit supply and demand less sensitive to changes in the policy rate. This can pose some challenges for central banks in achieving their inflation and output targets, especially in a low-interest rate environment. Central banks may need to adjust their policy instruments and communication strategies, and to coordinate more closely with other authorities, to ensure that their monetary policy stance is transmitted effectively and consistently across different segments of the credit market.
Consumer protection and fair competition: Fintech credit can raise some concerns about the protection and welfare of consumers and borrowers, who may not be fully aware of the costs, benefits, and risks of using fintech credit products and services. Fintech credit can also raise some issues about the level playing field and fair competition among different types of credit providers, who may operate under different regulatory frameworks and standards. Consumers and borrowers may need more education and information, and credit providers may need more harmonization and coordination, to ensure that fintech credit is transparent, accountable, and responsible.

Key takeaways

Fintech credit is a new form of lending that is enabled by online platforms and big data, and that offers some advantages over traditional bank credit, especially for SMEs and consumers who face difficulties in accessing bank loans.
Fintech credit can affect the economy and the transmission of monetary policy through three main channels: the interest rate channel, the balance sheet channel, and the bank lending channel.
Fintech credit shows a lower (and non-significant) sensitivity to monetary policy shocks compared to bank credit, reflecting a substitution effect and a limited impact on the collateral channel.
Fintech credit contributes to less than 2% of the variability of real GDP, while bank credit accounts for about a quarter of it, reflecting the still marginal, although fast-growing, macroeconomic significance of fintech credit in most countries.
Fintech credit can pose some implications and challenges for financial stability, monetary policy effectiveness, consumer protection, and fair competition, which require more attention and coordination from central banks and regulators.

P.S. What’s your take on the future of Fintech Credit? Do you see it as a game-changer in the financial industry? Share your thoughts below!

Disclaimer: The views expressed in this blog are not necessarily those of the blog writer and his affiliations and are for informational purposes only.

Read my other posts here: Conventional Finance - FinFormed, Islamic Finance - FinFormed, Takaful - FinFormed, Career - FinFormed and Randow Writings - FinFormed

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