Trust in Lending

This paper develops a theory of trust in lending, and uses it to analyze the potential market segmentation between banks and fintech lenders. Trust enables lenders to have assured access to financing regardless of market conditions, whereas a loss of trust makes this access conditional on market conditions and the perceived incentives of self-interested lenders to make prudent loans. As long as all lenders are viewed as trustworthy and the costs of operation are the same for banks and fintech platforms, banks capture the whole market. If fintech platforms can be operated significantly less expensively than banks, fintech lenders can attract relatively risky borrowers away from banks. But when borrower defaults erode trust in lenders, banks subject to effective regulatory surveillance are able to survive the erosion of trust when fintech lenders do not, and borrowers flee fintech platforms. Effective regulatory surveillance is thus a competitive advantage for banks.