Bankers under the impression that they have friends in high places might want to check back in with the Fed. Little-noticed in Chair Yellen’s exchanges at the Joint Economic Committee earlier this week was one with Sen. Cruz. In it, she unsurprisingly, if incorrectly, reiterated that small businesses think they’ve got all the credit they need. Then, she quite surprisingly went on to say that, if banks flee the small-business field, little worry – fintech is stepping in and, for good measure, perhaps doing it better than banks. For a Fed long fearful of shadow banks and wary of fintech, this was a startling statement.
Importantly, this answer came after Sen. Cruz argued that all the new rules have suppressed bank small-business lending. One could thus read Chair Yellen as saying that rules or no rules, small businesses are getting credit not only because they don’t seem to want any more, but also because unregulated companies are stepping in. Specifically, she said:
In terms of small business lending, the landscape has changed a lot. Perhaps community banks are providing less than they used to. Large banks are providing more, online lenders and new fintech firms are coming in and filling part of the void and devising new ways to lend quickly to small businesses in ways that are perhaps less costly than traditional banks.
So, game on. In a recent op-ed, I assessed the potential for platform companies to do to traditional financial institutions what Amazon has done to shopping for shoes at the mall – i.e., obliterate it. Although it may take some time for platform companies to reach deeply into the financial-intermediation value chain to pluck the parts that profit them the most, one of the earliest cherries on the tree surely is small-business lending. With as much as a $2 trillion credit gap around the world, the need is there and platform companies already have strong ties across the B2B and B2C chains that bind small businesses to their customers and ride along the platform all the way to what was once the bank.
In fact, platform companies in this space know their customers better – algorithmically speaking – than banks. Think about the records of transactions, trades, and customer reviews that could quickly lead to credit decisions. Banks have what I call “little data” – what the branch manager might know and what a borrower says on a credit application, information so heterogeneous that no efforts have yet produced automated underwriting suitable for large-scale origination. However, platform companies handling small-business transactions know more about their customers than the customer likely knows about itself. Deploying their seemingly all-powerful algorithms could quickly redefine not only the way small-business loans are delivered, but also how risky they are. Even more importantly, small-business lending funded by platform companies through cash reserves and small fees along the payment chain from the borrower upend a cornerstone of financial intermediation, changing not only the construct of fractional banking, but also the entire conceptual base of conventional monetary policy.
I’ll save for another day the question of whether fintech and online lenders are now less costly or otherwise preferable to banks, as Ms. Yellen suggests. What’s immediately important is that she has declared that, if banks can’t meet a key market need due to all the post-crisis rules, so be it. The rules will stay and customers may go elsewhere. Rules will change a little bit under a new Fed, but not enough to reverse the fundamental reality that many traditional financial-intermediation products can be easily disintermediated and then more profitably and perhaps even better offered by non-banks. It is for this reason that the Bank of England warned earlier this week that U.K. banks are under-estimating the strategic challenge they face, why the Basel Committee thinks banks face a grim future, and the FSB recently forecast a paradigm shift to platforms.
All’s fair in this fight, but not if banks labor under rules that are necessary for any entity offering banking services to ensure customer safety, market liquidity, and systemic stability. Banks are indeed unique in the taxpayer benefits they enjoy, but they enjoy these benefits so they can serve social-welfare and macroeconomic needs. Can these needs be met without rules and without the risks for which the bank safety net exists? We may well find out, hopefully not the hard way.