AI will decide if mortgage applicants get a bank loan

by Zain Jaffer

Remember that 1946 Jimmy Stewart film It’s a Wonderful Life? Where he plays George Bailey, a small town banker who has more friends than funds in his bank. Most businesses and entrepreneurs probably have a lot of bankers to thank for loaning them money that they returned to the banks with interest.

While the big Wall Street banks are still able to do well these days, and to some extent influence Washington to pass laws advantageous to them, the small town banks are not in the same space. Although the Fed instituted a Bank Term Funding program that allows banks to use their existing bonds and MBS at par/face value instead of market rate as collateral to borrow money from the Fed to lend out, their balance sheets are not good at the moment.

A lot of the smaller US banks like Signature and Silicon Valley Bank invested a lot of their depositors money from the pandemic handouts into what were considered safe ten year and thirty year US treasury bonds. Unfortunately for them, when the Fed started hiking rates in 2022 up to now, the market value of the older lower yielding bonds they were holding were now worth less. After all, wouldn’t you prefer a 5% ten year over a 3% ten year US treasury bond? So when analysts and depositors realized that many of these bank assets at that point in time had to be marked below par value in their books, bank runs ensued. The Bank Term funding program simply assured depositors that the banks had enough liquidity, although their asset values are still down.

Never mind if the bank could hold the older bonds to maturity, but they had to sell some to pay back their depositors. The situation was further exacerbated by commercial real estate like office space that were foreclosed in their books because the developers could not pay back the loans at the higher interest rates due to large numbers of office space vacancies, and lower demand for home mortgages at 7.5%.

Because of this, banks are now extremely selective in who they lend to. If you are just barely making it by, either as an individual or a company, your income or revenue is likely threatened by future economic conditions, and the banks assess that you can’t really complete the loan payments which are now at higher interest rates, then you probably won’t get the loan.

In order to ensure that tighter lending standards are enacted, artificial intelligence (AI) is now being used by some banks to assess who to give loans to. The days of talking to your banker to ask him to reconsider their decision to give you a loan is now disappearing. In its place are algorithms that determine based on some criteria if you will get that loan or not.

Unfortunately we don’t know if these algorithms are skewed towards some people in terms of race, education, and other potentially discriminatory factors. This of course has implications for who makes it through these tough economic conditions, and who doesn’t.

While the wonders of AI may impress many of us, it does have many implications about the way we have normally done business and do relationships with others. Obviously this is good news for some, but bad for others.

The era of a Jimmy Stewart as George Bailey in It’s a Wonderful Life may be coming to an end, but is that what we really want?