The Rise of Digital Lending

Traditionally, businesses and consumers have obtained loans from banks, credit unions, and other financial institutions. However, in recent years, alternative forms of credit have arisen from the burgeoning financial technology (“fintech”) industry and large, established technology companies like Amazon, Google, and Microsoft (“Big Tech”). Rapid credit growth can often forecast financial crises and recessions. Therefore, the recent rise in lending from the tech sector could have significant policy implications. Regulators must understand the scope and causes of this rise in alternative credit. In March 2023, a team of researchers in Switzerland and the UK, led by Giulio Cornelli at the University of Zurich, published a paper in the Journal of Banking and Finance about the significance of lending from Big Tech.

Cornelli et al. first explore how fintech and Big Tech lenders operate. Some of these firms partner with traditional financial institutions to leverage their data and networks but pass on the risk. Other fintech and Big Tech firms shoulder the full responsibility of their loans. Fintech and Big Tech lenders also have different business models. Fintech companies use decentralized platforms to connect individual lenders and borrowers, screen users, and report information on borrowers’ risk. Examples of fintech companies include Lending Club, SoFi, and OnDeck. On the other hand, Big Tech lenders only offer credit as a small part of their overall operations and employ user data to predict the riskiness of loans.

To study the expansion of digital lending, the researchers assembled a new database of global credit volumes offered by fintech and Big Tech lenders. The authors compiled a dataset of 79 countries spanning from 2013 to 2018, encompassing fintech lending data obtained from the Cambridge Centre for Alternative Finance (CCAF) and Big Tech lending data acquired from central banks and major tech companies. With this new data, Cornelli et al. found that total Big Tech lending was $10.6 billion and total fintech lending was $9.9 billion in 2013. In 2018, these figures exploded to $397 billion of total Big Tech lending and $297 of total fintech lending.

While these numbers are large and growing, alternative credit is still only a small fraction of total global lending. For example, fintech lending in the United States was only about $57.7 billion in 2018, or about 0.3% of Gross Domestic Product (GDP), and Big Tech lending was only $1 billion, primarily from Amazon’s seller lending program. For context, total credit to the private non-financial sector in the US is about $40 trillion, or about 140% of GDP. The importance of digital lending lies in its rapid expansion as the industry develops. As it continues to grow, digital lending will play an increasingly larger role in the overall credit market.

The researchers found that digital lending is more common in countries with higher incomes, larger banking profit margins, and looser banking regulations. Specifically, the authors observed a positive correlation between GDP per capita and total alternative credit per capita until GDP per capita reaches about $31,000, putting a country in the top 20% of the world’s wealthiest. Beyond this point, higher GDP per capita is inversely related to total alternative credit per capita. Similarly, each ten-percentage point increase in a country’s Lerner Index score, a measure of banking mark-ups, predicts a 14% increase in total alternative credit per capita. Lastly, the researchers use a regulation index to summarize financial institutions’ capital and disclosure requirements and countries’ supervisory agency power. The authors observed that when a country’s regulation index score exceeds the average by one standard deviation, they could expect a 0.5 percentage point decrease in the ratio of total alternative credit per capita. Together, these relationships indicate that the amount of digital lending varies based on several factors, and policymakers can use banking regulation to encourage or discourage digital lending.

To further test the data, the authors added an additional variable to measure whether a country has specific regulations for fintech. From 2013 to 2018, 21 countries wrote new regulations for fintech. The researchers found that explicit regulation of fintech predicted a 103% increase in fintech lending. Cornelli et al. propose that fintech regulations may arise in response to growing fintech credit volumes and that clear regulations may reduce the risk that policymakers will ban fintech lending in the future. The authors also found that when countries tighten their financial regulations, Big Tech lending grows faster than fintech lending. Perhaps this suggests that lawmakers may write new regulations too narrowly to encompass lending from Big Tech companies, or Big Tech companies may find it easier to comply with new regulations.

The economic bubble that hit Japan in the 1980s serves as a warning about the risks in alternative credit markets. During this time, excessive lending and a subsequent burst of the credit bubble led to Japan’s “Lost Decades,” a period marked by low economic growth. To mitigate this risk today and efficiently regulate the market, policymakers need to better understand the operations of fintech and Big Tech lenders. Similarly, regulators should collect more data about tech credit volumes for transparency to the public and to allow for the standardization of regulation across both alternative and traditional lenders. Implementing these measures in fintech and Big Tech lending would foster a safe avenue for growth while managing risks, ultimately increasing global access to loans for underserved borrowers.

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Cornelli, G., Frost, J., Gambacorta, L., Rau, P. R., Wardrop, R., & Ziegler, T. (2023). Fintech and big tech credit: Drivers of the growth of digital lending. Journal of Banking & Finance, 148, 106742. https://doi.org/10.1016/j.jbankfin.2022.106742