The increased use of information technology and data analysis in the business lending market makes it cheaper and easier for banks and other lenders to analyse information about business collateral, making it easier for young firms to get funding.
This is the finding of a new paper from the monetary and economics department of the Bank for International Settlements: Does IT help? Information technology in banking and entrepreneurship.
“Banks’ IT adoption can increase dynamism by improving start-ups’ access to finance,” it says.
For anyone who has ever wondered about the validity of all the claims fintechs and established lenders make about their automated decisioning, AI-assisted data analysis and so on, this is a useful read.
“Over the last decades, banks have invested in information technology on a grand scale. However, there is little evidence on the effects of this IT revolution in banking on lending and the real economy.
“Meanwhile, the role of fintech companies that rely on IT, rather than loan officers, to provide credit to small businesses has been steadily increasing. These developments have triggered a debate on the impact of IT adoption in the financial sector and on the real economy”
The paper uses US market data and focus on how easily new businesses can get finance. It does this because of the impact start-ups have on employment, innovation and growth, and because start-ups are usually “opaque borrowers that are likely to be especially sensitive to technologies that affect lenders’ information acquisition.”
It says IT facilitates real estate appraisal and collateralised lending, which is the dominant form of lending to US start-ups.
“IT reduces the costs of several real estate related processes, for example by expediting appraisal, research and sales. It also facilitates the flow of information, such as values.”
“This benefits start-ups, as they have not yet produced sufficient information [about their business activities] and have to provide collateral. Entrepreneurs often pledge their home equity as collateral.”
The authors also tracked IT take-up by banks in the United States and found that in areas where IT-intensive banks operate, there is a pattern of “stronger job creation by start-ups”.
The paper also says that IT provides better screening tools, with the result that financing more start-ups does not lower the quality of the businesses being financed. “Stronger firm formation does not result in more exits,” it says.
The authors say their findings could have implications for financial sector policy. They raise the prospect that mandated improvements in financial technology could ease financial constraints for young and dynamic firms.