Does IT help? Information technology in banking and entrepreneurship

(February 2022, revised August 2024)

Summary

Focus

Information technology (IT) has dramatically changed how information is used in the financial sector. This may affect the supply of credit from banks, as a key function of banks is to screen and monitor borrowers. Lending to opaque borrowers, such as young firms and start-ups, is likely to be especially sensitive to such changes in IT. The reason is that young firms have not yet produced sufficient quantitative information, such as balance sheet data. Instead, lenders rely on soft information. As start-ups contribute disproportionately to job creation and productivity, but are often financially constrained, understanding how the IT revolution in banking has affected start-ups' access to finance is of paramount importance. Yet, direct evidence for the impact of lenders' IT capabilities on entrepreneurship is scarce.

Contribution

First, our paper relates to the literature investigating the effects of IT in the financial sector on credit provision and small businesses. Second, we speak to papers that analyse the importance of collateral for entrepreneurial activity. We provide first evidence that banks' IT adoption increases the importance of collateral in banks' financing of young firms. Third, we contribute to the recent literature that investigates how the rise of fintech affects credit-scoring and credit supply. An advantage of focusing on the variation in IT adoption among banks is that our results are unlikely to be explained by regulatory arbitrage, which has been shown to be an important driver of the growth of fintechs.

Findings

We build a model in which banks can screen firms either by acquiring information about firms and their projects or by requiring collateral. Crucially, IT makes it cheaper for banks to analyse hard information and thus rely on collateralised lending. This benefits start-ups, as they have not yet produced sufficient information and have to be screened through the use of collateral. The model thus predicts that IT in banking will spur entrepreneurship – and the more so when collateral value rises. Consistent with the model's implications, we find that job creation by start-ups is stronger in US counties with IT-intensive banks, especially during periods of rising collateral values.

Abstract

We study the importance of information technology (IT) in banking for entrepreneurship. Guided by a parsimonious model, we establish that job creation by young firms is stronger in US counties more exposed to banks with greater IT adoption. We present evidence consistent with banks' IT adoption spurring entrepreneurship through a collateral channel: entrepreneurship increases by more in IT-exposed counties when house prices rise. Further analysis suggests that IT improves banks' ability to determine collateral values, in particular when collateral appraisal is more complex. IT also reduces the time and cost of disbursing collateralized loans.

JEL classification: D82, G21, L26

Keywords: technology in banking, entrepreneurship, information technology, collateral, screening.