Box 2.2. Fintech credits: From competition to collaboration

coPIng wItH sHocks: mIgRAtIon And tHe RoAd to ResIlIence

Box 2.2. Fintech credits: From competition to collaboration

South Asian countries have witnessed a tremendous increase in the use of digital payments. As Fintech matures into later stages of development, increased Fintech credit flows can affect traditional banks’ risk-taking and lending practices. For example, as traditional banks adopt Fintech or partner with Fintech firms, the technology allows banks to better manage and mitigate risks.17 This box measures the impact of Fintech on traditional banking’s risk-taking behavior.

To shed light on the interaction between Fintech and traditional banks, we estimate the relationship between bank risk-taking and the presence of Fintech credit flows in the economy, controlling for bank-specific and economy-wide factors:18

Bank Risk-Takingjt = α + β1FinTech credit flows as share of GDPit+ β2BankFactorjt + β3MacroFactorit +λj+ λ t + εjt

The relationship is estimated for a panel of 2041 banks (j) across 35 countries (i) and over five years (t) between 2014-2019. The estimation sample comes from the S&P Capital IQ database and includes 52 banks from South Asia (India and Pakistan). Appendix A.2.1 gives more details on the construction of the variables and the set of control variables included.

The regression results reveal important variations across different stages of Fintech credit flows. In the initial stage, the interaction between Fintech and traditional banks is characterized by competition. The presence of Fintech credits in the market can incentivize traditional banks to lend to ‘riskier’ borrowers, as the competition from Fintech increases banks’ risk-taking behavior (Guo and Shen 2016; IMF 2022; Wang, Liu, and Luo 2021). Results from the regression on a subsample between 2014 and 2015 (Figure 2.12.A) show that a one percent increase in Fintech credit flows (as a percent of GDP) was associated with a 1.9 point rise in banks’ risk-taking. This period represents the early stage of Fintech lending, as Fintech credit flows are still relatively low. At this early stage, FinTech serves riskier borrowers. As the sector gradually develops

17 For example, if a traditional bank partners with a digital platform (e.g., Uber), the recourse tool offered by Uber automates the vehicle loan repayment from the driver. From bank perspective, the loan repayment is guaranteed by Uber through driver’s future transactions. If the same loans were issued by the bank to the same driver without the digital platform as intermediaries, then the driver might not pay back the loan. By providing recourse tools, Uber helps mitigate risk of the banks’ lending and allows the bank to expand into new lending areas. 18 Banna, Hassan, and Rashid (2021), Liao (2018), and Wang, Liu, and Luo (2021) use similar estimation strategies but different explanatory variables, data set or sample.