Please rotate your device to landscape mode to view the charts.

Fintech Borrowers: Lax Screening or Cream-Skimming?

Journal: Review of Financial Studies

Date: 20211001

Author: Di Maggio, Marco; Yao, Vincent

Abstract:
We study the personal credit market using unique individual-level data covering fintech and traditional lenders. We show that fintech lenders acquire market share by lending first to higher-risk borrowers and then to safer borrowers, and rely mainly on hard information to make credit decisions. Fintech borrowers are significantly more likely to default than neighbor individuals with the same characteristics borrowing from traditional financial institutions. Furthermore, they tend to experience a short-lived reduction in the cost of credit, because their indebtedness increases more than non-fintech borrowers after loan origination. However, fintech lenders' pricing strategies are likely to take this into account.

Link: Google Scholar

Key Findings

Market Entry Strategy

Fintech lenders first target less creditworthy borrowers and gradually improve borrower quality over time, with credit scores increasing from 668 to 703 as lenders establish market presence.

Loan Performance

Fintech loans show 1.1% higher default probability compared to traditional loans, with borrowers experiencing increased total indebtedness and revolving balances after origination.

Pricing Strategy

Fintech lenders charge higher rates to lower-score borrowers (~3% higher) but offer better rates to high-score borrowers (~1.5% lower), with rates more strongly correlated with default probability.

Evolution of Borrower Quality Over Time

  • Average credit score increases from 668 to 703 for fintech borrowers
  • Traditional lenders show more modest improvement from 631 to 679
  • Gap between fintech and traditional lender borrower quality widens over time

Loan Default Rates Over Time

  • Fintech loans show consistently higher default rates starting from month 5
  • Default probability increases to 1.7% by month 15 for fintech loans
  • Gap in default rates widens over time post-origination

Interest Rate Differentials by Credit Score

  • Fintech lenders charge 2.8% higher rates for low credit score borrowers
  • High credit score borrowers receive 1.5% lower rates from fintech lenders
  • Rate differential is smaller in markets with low fintech penetration

Contribution and Implications

  • First comprehensive study showing fintech lenders' reliance on hard information for credit decisions
  • Demonstrates higher default risk but more accurate risk-based pricing by fintech lenders
  • Highlights need for regulatory oversight regarding borrowers' ability to service unsecured debt

Data Sources

  • Credit score evolution chart based on Table 2 showing fintech loan attributes by years of entry
  • Default rates visualization derived from Table 8 dynamic effects analysis
  • Interest rate differential chart constructed using data from Table 4 panel B analysis of loan terms