How magic a bullet is machine learning for credit analysis? An exploration with FinTech lending data

FinTech online lending to consumers has grown rapidly in the post-crisis era. As argued by its advocates, one key advantage of FinTech lending is that lenders can predict loan outcomes more accurately by employing complex analytical tools, such as machine learning (ML) methods. This study applies ML methods, in particular random forests and stochastic gradient boosting, to loanlevel data from the largest FinTech lender of personal loans to assess the extent to which those methods can produce more accurate out-of-sample predictions of default on future loans relative to standard regression models. To explain loan outcomes, this analysis accounts for the economic conditions faced by a borrower after origination, which are typically absent from other ML studies of default. For the given data, the ML methods indeed improve prediction accuracy, but more so over the near horizon than beyond a year. This study then shows that having more data up to, but not beyond, a certain quantity enhances the predictive accuracy of the ML methods relative to that of parametric models. The likely explanation is that there has been data or model drift over time, so that methods that fit more complex models with more data can in fact suffer greater outof- sample misses. Prediction accuracy rises, but only marginally, with additional standard credit variables beyond the core set, suggesting that unconventional data need to be sufficiently informative as a whole to help consumers with little or no credit history. This study further explores whether the greater functional flexibility of ML methods yields unequal benefit to consumers with different attributes or who reside in locales with varying economic conditions. It finds that the ML methods produce more favorable ratings for different groups of consumers, although those already deemed less risky seem to benefit more on balance.