Tech in Finance before FinTech: Effect on Financial Stability
Nicola Pierri - International Monetary Fund (IMF);
Yannick Timmer - International Monetary Fund (IMF)
-- The emergence of FinTech has triggered a debate on the effect of Information Technology on financial stability. The recent literature on FinTech has mostly focused on how the latest technological developments have been changing the way information is processed and the relative consequences for credit allocation and performance. However, the era of FinTech has not been exposed yet to large shocks testing its resilience. Therefore, the FinTech literature cannot directly speak to the link between technology and financial stability, as predictive systems which are accurate in good times may fail to predict default during a crisis.
To understand the potential impact of technology adoption in lending on financial stability, in our recent pap, "Tech in Fin before FinTech: Blessing or Curse for Financial Stability?", we shed light on how banks with a varying degree of pre-GFC IT adoption fared when the crisis hit. To evaluate banks’ resilience, we study the evolution of their non-performing loans which are considered an important indicator of banking sector distress. The direction of the impact of IT adoption on banks’ resilience to a crisis is a-priori ambiguous. On one hand, IT can improve monitoring and screening by enhancing the collection, storage, communication, and processing of information. On the other hand, banks with more IT might rely too much on “hard” information, which are easier to report and communicate, inducing them to neglect “soft” information and to take on too much risk.
In our paper we show that banks that adopted IT more intensely before the GFC were significantly more resilient when the crisis hit. These banks had significantly fewer non-performing loans and issued more loans during the crisis. Loan-level analysis illustrates that high-IT adoption banks originated mortgages with better performance, did not offload low-quality loans, and were more likely to reject applicants in areas where house prices subsequently dropped more. In normal times technology adoption is not correlated with banks’ performance. This result reinforces the argument that it is important to study the effects of IT adoption when the economy faces a system-wide shock.
The evidence presented in our paper suggests that the ``FinTech era'' is likely to be beneficial to financial stability. While an obvious limitation of our approach is that the type of technologies employed by commercial banks in the early 2000s might be different than today’s use of machine learning and big data, we can examine a period of severe and systemic turmoil by using historical data that the growing FinTech literature cannot. Another strength of our approach is that it is likely to be more representative since our sample covers the vast majority of lending in the pre-crisis period, while FinTech is still a small fraction of credit markets. Because of these important trade-offs the results presented in this paper should be seen as relevant complement, rather than a substitute, to this literature.
Disclaimer: The views expressed herein are those of the author and should not be attributed to the IMF, its Executive Board, or its management.