Consumer leading efficiency: Commercial banks versus a fintech lender

Using 2013 and 2016 data, we compare the performance of unsecured consumer loans made by U.S. bank holding companies to that of the fintech lender, LendingClub. We focus on the volume of nonperforming unsecured consumer loans and apply a novel technique (Hughes and Moon 2017) that decomposes the observed rate of nonperforming loans (NPLs) into three components: a best-practice minimum ratio, a ratio that gauges nonperformance in excess of the best-practice (reflecting the relative proficiency of credit analysis and loan monitoring), and statistical noise. Stochastic frontier techniques are used to estimate a minimum rate of nonperforming consumer loans conditioned on the volume of consumer loans and total loans, the average contractual lending rate on consumer loans, and market conditions (GDP growth rate and market concentration).

This minimum gauges best-observed and answers the question, what ratio of nonperforming consumer loans to total consumer lending could a lender achieve if it were fully efficient at credit-risk evaluation and loan management? The frontier estimation eliminates the influence of luck (statistical noise) and gauges systematic failure to obtain the minimum ratio. The conditional minimum ratio can be interpreted as a measure of inherent credit risk. The difference between the observed ratio, adjusted for statistical noise, and the minimum ratio gauges lending inefficiency. In 2013 and 2016, the largest bank holding companies with consolidated assets exceeding $250 billion experienced the highest ratio of nonperforming consumer loans among the five size groups. Moreover, the inherent credit risk of consumer lending is the highest among the five groups, but lending efficiency is also the highest. Thus, the high ratio of consumer nonperformance of the largest financial institutions appears to result from assuming more inherent credit risk, not from inefficiency at lending.

In 2016, LendingClub’s scale of unsecured consumer lending is slightly smaller than the scale of the largest banks. Like large lenders, its relatively high NPL ratio is the result of a higher best-practice ratio of nonperforming consumer loans- i.e., higher inherent credit risk. As of 2016, LendingClub’s lending efficiency is similar to the high average efficiency of the largest bank lenders, a conclusion that may not be applicable to other fintech lenders. While the efficiency metric is well-accepted, widely used, and conceptually sound, our data does not include lending performance during an economic downturn when delinquency rates would be higher and when lenders more experienced with downturns might achieve higher efficiency.