Examination of the effects of fintech lending on firm policies reveals that firms access fintech to obtain long-term unsecured loans and reduce their exposure to less well-capitalised banks. Ultimately, fintech allows firms to improve their financial flexibility and reduce bank dependence.
Traditionally, small and medium enterprises (SMEs) in Europe relied exclusively on banks for their credit needs. Today, SMEs can raise debt through peer-to-business (P2B) platforms, which are technology-enabled platforms that intermediate an online match between (retail) borrowers and lenders. In Europe, there are 146 lending platforms of which half are directed to small business lending, which in 2017 alone raised business funding of €534 million for approximately 10,000 businesses.
These fintech platforms allow investors to directly select prospective loans based on a range of credit information such as loan purpose, borrower industry, loan term, borrower income and other credit quality information. The platform we study, a leading Portuguese independent fintech platform, also screens the firms based on both hard and soft information as obtained from the SMEs themselves to select appropriate investment opportunities for the investors.
The platform granted access to 1,291 loans from the launch of the platform in December 2016 through September 2019, whilst rejecting 1,906 applications over the same period. The mean loan is about €22,500 and represents 17% of the firm’s assets and 29% of the firm’s debt, indicating that fintech loans are an economically significant source of debt financing for SMEs. The P2B loans have, on average, three-year maturity and an interest rate of 7%, which is significantly higher than the interest paid on other types of debt that firms in our sample obtain from traditional financing sources. We combine these data with administrative databases that report financial statements for the universe of non-financial firms, financial statements for banks, and matched bank-firm loans from the Central Credit Register. A crucial aspect of our data is the availability of information about both the firms who manage to borrow through the P2B platform and the firms who apply but get rejected by the platform, including financial data and the characteristics of the banks serving these firms. This feature allows us to study the determinants of the demand for fintech lending, but also to investigate the firm-level consequences of obtaining a fintech loan holding fixed such a demand.
Which firms apply for and obtain fintech credit? One of the main determinants to obtain access to the platform is for firms to have prior lending relationships with the banking sector. Fintech seems to be very much servicing the same clients as traditional financial intermediaries and not the underserved risky firms with no prior access to the banking system. When we compare the characteristics of firms that access P2B lending to firms that borrow from traditional financial intermediaries, we find that firms that borrow through P2B platforms are larger, have lower credit risk, and already have access to bank credit. What fintech is offering is a different product, long-term unsecured debt which banks are reluctant to give to SMEs. With this long-term debt, SMEs can fund long-term projects like investment in research and development (R&D) or intangibles.
Additionally, the characteristics of the banks servicing the SMEs are key in the firm’s decision to raise debt through a P2B platform, in particular the liquidity and solvency ratios of the banks. Firms served by banks with less liquid assets, less stable funding, and lower capital ratios are more likely to apply for P2B funding.
Fintech very much operates as a capital market alternative to banks for SMEs and helps these firms obtain a credible outside option to improve their bargaining power with respect to their current lenders. Upon being granted fintech credit, these firms reduce their collateralised exposure to the banking system and instead supplement the fintech loan with additional short-term bank debt.
Access to the P2B platform allows SMEs to further diversify their pool of lenders. P2B loans allow firms to add new bank relationships, and reduce their dependence on a single bank, as indicated by a drop in the share of firm debt accounted by its main bank and a reduction in debt concentration in the years following the fintech credit.
Through fintech borrowing, SMEs can achieve both higher financial flexibility and protect themselves against the risk of lending cuts by diversifying their financing sources from less liquid and solvent banks. Since fintech loans are unsecured, these results point also at another important determinant of firms’ choice to apply to fintech platforms. Specifically, there are several reasons why SMEs may prefer to finance their growth with long-term debt. For example, they want to avoid the refinancing risk inherent in short-term debt. However, most SMEs are limited in their availability of collateral, and tighter regulation and higher capital requirements make long-term unsecured loans to SMEs unattractive to banks. Fintech provides firms with an alternative to access unsecured long-term financing.
This has important long-term consequences for the growth of these firms. We study the impact of fintech lending on firm growth and investment, and document a strong positive effect on firm growth. Firms that access fintech lending experience a significant increase in asset growth, employment growth, and sales in the years following relative to the control group of rejected applicants. By comparing accepted applicants to firms who applied but got rejected by the platform, we can effectively hold fixed the demand for fintech credit, focusing on the real effects of its supply.
As technology changes the competitive landscape for financial intermediation, it seems fintech becomes a complement to the credit offering of SMEs. Fintech provides firms with an alternative to access unsecured long-term financing to finance long-term investment projects and allows SMEs to retain financial and operational flexibility and reduce their dependence on banks.
For SMEs contemplating shifting from traditional banking to fintech platforms they should realise that fintech platforms do not seem to serve young, untested firms with no prior access to the banking system. Thus, the benefits of fintech do not seem to lie in increased financial inclusion of small businesses. Fintech, however, does offer SMEs a different type of debt, long-term unsecured debt, to finance their long-term investment projects. The fact that SMEs are interested in securing long-term fintech debt also aligns well with the notion that firms in our sample want to protect themselves against credit supply shocks by becoming less dependent on banks to minimise the impact of future financial constraints.
About the Author
Melissa Porras Prado is a Full Professor of Finance at Nova School of Business and Economics. She has a PhD in Finance from RSM Erasmus University. Her research focuses on understanding how financial intermediaries and institutional investors make decisions and in turn influence capital markets. Her published works can be found in the Journal of Finance, Journal of Financial Economics, and Review of Financial Studies, among others.
