Artificial intelligence, machine learning, and big data will transform financial services and small-business lending long before they impact driverless cars, predicts Harvard Business School Senior Fellow Karen G. Mills. “As we speak, large banks and fintech providers are working on solutions that will dramatically change the options for small businesses.”
Her new book, Fintech, Small Business, & the American Dream: How Technology is Transforming Lending and Shaping a New Era of Small Business Opportunity, explains why small business is key to the United States economy, and how innovation in financial services will reduce the friction and barriers in small-business lending, helping more of them thrive. In our Q&A, Mills, who served as a member of the Obama Cabinet and headed the US Small Business Administration from 2009 to 2013, outlines the challenges and opportunities facing small businesses, the rise of fintech innovation, and the policy implications for regulation.
Lagace: How does the US small business landscape look now?
Mills: There are 30 million small businesses and they are absolutely critical to the US economy. Half of the people who work in this country own or work for a small business. So that’s half the jobs. Sometimes small businesses don’t have a seat at the table with policymakers in Washington or in economic models, but they are, in fact, vital to job creation, economic mobility, and the fabric of our communities.
Lagace: As you write in the book, the number of small-business starts has been declining. Why?
Mills: This decline in starts is extremely worrisome. We used to average 500,000 to 600,000 small businesses starting every year in the US. That fell abruptly in the Great Recession and has not come back. There are a number of theories about too much regulation, for example, or too much student debt, but it is a problem because small businesses provide a path to the American dream. Traditionally, immigrants have over-indexed in small business starts. That is the story of my family. If we want to have a more equitable economy, if we want America to continue to be the land of opportunity, we need to pay close attention to this trend.
Lagace: What are the sticking points in getting access to capital?
Mills: When I came to Harvard and began to study small-business lending, it was clear there were structural issues. It was not cost effective to make a small-dollar loan using a traditional relationship manager. We identified a funding gap in the smallest dollar loans—those under $100,000. The smallest businesses who wanted the smallest loans were not being well served, in part because it was hard to know whether they were actually creditworthy.
The advent of technology and the entrance of new fintech entrepreneurs began to change that by improving the speed and ease of the small business customer experience, and making their financial activity more visible to potential lenders.
Lagace: How much do small-business owners want fintech?
Mills: When owners were able to go online, fill out an application in minutes, and get an answer the same day and money in their bank account the next day, they flocked to the new lenders. Some issues arose quickly, though, such as high prices and bad actors charging hidden fees.
The initial innovation that fintechs brought was in the front end of the application process, automating it and making it digital first. Soon, however, big banks woke up and realized they did not have to cede this market to the disruptors. JP Morgan, Bank of America, and Wells Fargo all started working on new solutions. Big tech companies also got involved. Amazon, PayPal, and Square developed lending operations, and American Express and Capital One entered the field. Now there is a wide array of large and small companies investing deeply in tech, all centered around recreating the lending experience for small businesses. This is incredibly exciting.
Lagace: What are the regulatory hurdles?
Mills: In the book, I have two chapters on regulation. Often people find regulation boring, but we are at a critical juncture. Decisions we make over the next several years will influence large parts of our financial services systems. In the US there are seven agencies overseeing banks and lending, yet issues relevant to small-business lending—such as disclosure rules—have often fallen through the cracks. For example, if you are a consumer and you buy a truck, all costs and financing fees must be clearly disclosed. But if you buy the same truck for your snow removal business, you’re on your own. This must change.
A more complicated set of regulatory issues is looming around big data and artificial intelligence. My book focuses attention and predictions on what the world will look like as big data, AI, and machine learning come into financial services—lending in particular—in full force. This trend will be transformative. With the ability to aggregate and organize data and analyze it rigorously, lenders can have more predictive algorithms about who is creditworthy, and small business owners can have a dashboard that will help them understand and predict their cash needs. These two activities could perhaps improve small business longevity and maybe turn around this worrisome trend in small business starts.
We have a long way to go in Washington to be fully engaged and intelligent about these issues. Fortunately, small business is one place where there is a lot of bipartisan agreement. I believe we can make progress and give small businesses the results they deserve.