FAU Study: Entrepreneurs Getting Big Boost from Online Lending

States Restricting Marketplace Lenders Reduce Entrepreneurial Activity

Online marketplace loans are leading to a sharp rise in new businesses, evidence that the lending platforms are helping to redefine the U.S. banking industry, according to a research team that includes professors at Florida Atlantic University.

The financial technology (FinTech) study, published in the Journal of Financial and Quantitative Analysis, estimated that a 10 percent increase in marketplace lending caused a .44 percent jump in businesses established per capita. 

The impact is even greater for less-experienced entrepreneurs and small and less-profitable firms and in low-income areas, noted Douglas Cumming, Ph.D., and Sofia Johan, Ph.D., both of FAU’s College of Business. Their research team included Hisham Farag, Ph.D., and Danny McGowan, Ph.D., both of the University of Birmingham in the United Kingdom. 

“When we started this study, we expected that FinTech funding would help entrepreneurship, but we were surprised to the extent to which it did help,” Johan said.   

Marketplace lending platforms such as Lending Club and Prosper emerged in the mid-2000s and have soared in popularity over the past decade, originating roughly $6 billion of business loans annually in the United States, the study revealed. They provide faster and cheaper access to credit than traditional lenders, enabling start-ups and other businesses to grow. 

The study points out that marketplace lenders expand the credit supply by capitalizing on digital algorithms in credit modeling to identify borrowers with “observably poor but actually good credit quality.” While traditional lenders may use similar technology, bank-lending criteria do not allow them to lend to those borrowers, according to the researchers. 

Also, marketplace lenders use digital technologies that reduce origination costs, meaning lower interest rates compared to traditional lenders.

“By reducing the cost of credit, marketplace lenders reduce potential entrepreneurs' expected operating costs, leading those that were previously unprofitable at the margin to enter,” the study stated. “Overall, relative to traditional banks, there are reasons to expect that marketplace lending has a disproportionately positive impact on entrepreneurship, particularly for constrained entrepreneurs that might be viewed as lower quality” borrowers.

The study compares the increase in entrepreneurial activity in states that restrict marketplace lending (Idaho, Indiana, Maine, Mississippi, Nebraska, North Dakota, West Virginia and Iowa) to the states that did not restrict online marketplace lending. While removal of these restrictions in recent years has benefitted these states, there are nevertheless costs to having had less entrepreneurship and a slower start to developing online marketplace in those regions.

“By having restrictions on marketplace lending, those eight states really lost out and had less entrepreneurship than what they would have had otherwise,” Cumming said. 

As America’s economy struggles to come back from the COVID-19 pandemic, states with increased marketplace lending have benefited more. Cumming’s current work shows that online lending has been much more stable, timely and resilient in the Covid-19 pandemic compared to bank consumer lending. 

Cumming and Johan said this study is part of their ongoing research into the growth of FinTech, and more specifically equity crowdfunding and marketplace lending, as they gain momentum as an important source of external finance for entrepreneurs and firms.

“With recent developments in FinTech, our goal as finance professors is to guide students to adapt to changes in the landscape of sources of finance for businesses,” Johan said. “We want to help FAU students not only become more valuable to companies in the FinTech industry, but also to other companies that have to be ready for FinTech.”

 -FAU-