Fact of the Week: Fintech Competition Induces Commercial Banks to Invest More in ICT

Source: Zhiguo He at al., “Investing in Bank Lending Technology: IT Spending in Banks,” NBER Working Paper Series, no. 30403, August 2022.

Commentary: In a recent working paper from the National Bureau of Economic Research, Zhiguo He et al. found that after state regulators approved the operations of fintech company LendingClub, commercial banks in those states increased their investments in information and communication technologies (ICT) by 7 percent, and large banks increased their spending by 11 percent.

This finding was consistent with the authors’ observation of the relationship between spending on software and loan-portfolio structure. The authors found that banks with the largest share of personal loans in their portfolios (especially mortgages) invest more in software. This is because personal loans rely more heavily on processing readily available “hard” data to make lending decisions (e.g., credit scores, income, etc.), which naturally places greater importance on data-processing software.

As decentralized facilitators of “peer-to-peer” lending, fintech companies must rely almost entirely on available hard data to make risk assessments. Thus, these firms represent first and foremost a competitive threat to existing banks’ hard-data-intensive operations, such as mortgage lending. Rather than shrinking from this threat and shifting resources to a less-affected area such as small-business lending, commercial banks instead increase investments to compete with potential fintech disruptors.

So, the threat of competition from fintech companies propels innovation in the commercial banking sector as it induces commercial banks to increase their investments in efficiency-enhancing software to stay competitive.