Will fintech innovation benefit borrowers of all incomes?
Financial technology (“fintech”) firms provide financial services by relying on new technology and innovation. But as this industry takes off, will fintech bring underserved consumers into the financial mainstream or simply improve the experience for those already in the market?
A postcrisis burst of innovation is bringing exciting changes to a variety of traditional financial services, ranging from payment processing and e-documentation to credit underwriting and lending. This underscores the critical need for inclusion in fintech.
A recent Urban Institute panel discussed fintech products that illustrate the different direction such products can take. Nonbank fintech lenders tend to make mortgage lending more convenient and efficient for wealthier consumers who already have access to banking services. Other products, like PayActiv and SalaryFinance, improve banking options for low-income working families with more limited banking opportunities.
Tomasz Piskorski, professor of real estate finance at Columbia University, discussed findings from research he and his coauthors Greg Buchak, Gregor Matvos, and Amit Seru conducted on the growing role of nonbank fintechs in mortgage lending. Drawing a distinction between traditional banks, nonbank fintechs that lend heavily using technology platforms, and nonbank non-fintechs, Piskorski and his coauthors showed that nonbank fintech lenders tend to create value by offering ease of use and convenience to consumers willing to pay extra for it.
Indeed, a separate study from researchers at the Federal Reserve confirmed that fintech lenders reduce loan processing time (the number of days from application to closing) by an average of 10 days, or a 20 percent reduction in the average processing time.
Piskorski and his coauthors found that these fintech borrowers tend to be more creditworthy and have higher incomes. They also showed that interest rates for mortgages originated by nonbank fintechs are, on average, 14–16 basis points higher than rates charged by traditional banks.
Nonbank non-fintechs were the least expensive of the three groups, charging 3–5 basis points less than banks. These findings suggest that technological innovations in mortgage lending tend to be geared toward wealthier borrowers, at least for the time being.
To serve the underserved, fintech can rely on innovation
A different picture emerges when one looks outside the mortgage lending space. Some fintech firms have created a niche by serving low- and moderate-income consumers who are not served well by the mainstream banking system.
Todd Baker, senior fellow at the Harvard Kennedy School, discussed the role fintechs are playing in reforming the market for short-term, small-dollar credit products such as payday, title, or pawn loans that often come with high and even predatory interest rates.
Baker showed that the adverse effects of these products harm not only consumers but their employers as well because of reduced employee productivity, absenteeism, and turnover. Turnover in particular tends to be very expensive, costing employers an average of $3,000–$6,000 to replace an employee. This can quickly add up to millions of dollars in costs for large retailers like Walmart or Target that need to replace tens of thousands of low-wage workers every year.
This is where fintech innovation is making a real difference. For example, PayActiv offers employees of participating employers an “earned income advance,” which gives employees access to a portion of their earned income before payday, helping them avoid expensive short-term, small-dollar credit products. This is a win-win because the partnership with employers significantly reduces the risk of default, allowing PayActiv to charge consumers just $5 per use, often subsidized by the employer.
Another fintech, SalaryFinance, offers online installment loans to employees of participating employers, which are repaid directly from the employee’s salary. This allows SalaryFinance to charge employee borrowers annual percentage rates around half as high as open market alternatives.
Fintech products serve different consumers in different ways. As policymakers seek to understand and nurture this industry, it is important to understand what specific benefits new fintech products bring and which consumers will most benefit from their adoption.
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