Fintech lending may increase consumers’ financial vulnerability

Contradictory to the prevailing theory that fintech companies — utilizing cutting-edge algorithms and incorporating data beyond the standard credit reports — have better insights into borrower risk profiles than traditional lenders, new research indicates that fintech borrowers are more likely to default on their loans than their counterparts who utilize traditional banks. In their forthcoming article in The Review of Financial Studies, Marco Di Maggio and Vincent Yao find that fintech companies are actually more reliant on “hard information” than traditional banks and typically acquire market share by first lending to higher-risk borrowers and then to safer borrowers. Although their analysis is based entirely on the personal loans market, the research raises another flag, adding to a growing list of fintech issues ripe for regulation.

The analysis utilizes a proprietary dataset from one of the nation’s largest credit bureaus which includes information on individual loans, billions of credit trades, and more than 200 million consumer credit files. The study leverages panel data on individual borrowers of unsecured personal loans — which are more easily comparable across lenders and one of the fastest growing consumer credit segments — across many lending institutions, bringing a unique perspective to the research area which has traditionally focused on data from single lenders.

The research found that borrowers who utilize fintech lenders for unsecured personal loans are more likely to use these loans to consolidate credit card debt, then overextend their credit card utilization, resulting in higher rates of loan default. Fintech lenders are also more reliant on hard information from traditional credit reports in making loan decisions than originally thought, according to the authors. Although fintech lenders face greater rates of loan default, the study also shows that borrowers are more likely to repeatedly access the same companies for loans which helps to counteract the expected higher prices in a market with greater combined risk.

Despite its differences from previous research which indicated that fintech lending may reduce racial discrimination and other barriers to accessing credit markets, as well as provide tools and services that could bolster consumer financial literacy and security — this study provides more context that should be carefully considered by policy makers as they increasingly turn their attention to regulating the fintech industry. Utilizing similarly complex and complete data, additional research which explores other types of loans (e.g. mortgages, home equity, student loans, etc.) would be useful for future policy discussion. Similarly, such extensive data could enrich research and policy discussions on discrimination in the financial sector.