Are Algorithms Biased?

A study by professors at the University of California, Berkeley titled, "Consumer-Lending Discrimination in the Era of Fintech”, looked at the lending landscape and whether the use of online platform had decreased discrimination in lending. Fintech algorithms have not removed discrimination but may have shifted the mode, according to the report.

The research revealed that ethnic discrimination in lending takes place in face-to-face decisions as well as in algorithmic scoring. It indicated that interest rate discrimination is almost identical for fintech lenders (5.3 basis points extra paid by minorities) as for the overall set of lenders (5.6 basis points).

The study noted that Latino and African-American borrowers pay between $250 million and $500 million extra in mortgage interest every year, which is 16.9 basis points higher in extra mortgage interest.

An increase in competition and shopping are two defining traits of the fintech era. Face-to-face lenders have additional freedom to discriminate, not just because of racism and in-group bias, but because they may use soft information differentially across borrowers, the report noted.

Robert Bartlett, the co-author of the study, said, “On a $300,000 online mortgage application, an African-American or Latino applicant would need to pay just under 1 percent—or around $2,000 more upfront in "discount points" or prepaid interest to secure the same mortgage rate as a white applicant.

In refinance loans, the researchers found that minorities pay just 1-3 bps in higher interest rates as a result of monopoly price extraction of rents being easier in transactions where borrowers are less-experienced or are acting in a more urgent time frame, the report said.

The overall mean difference in the mortgage interest rate between white ethnicities and, Latino and African-American ethnicities is 0.169 percent or 16.9 bps. Of this amount, 8.31 basis points are explained by the monthly dummy variables and the GSE grid effects, leaving 8.57 basis points of discrimination.

"Conventional lenders are leaving money on the table — they're turning away black and Latino borrowers that would appear to be acceptable," Bartlett said. "Those applicants are in turn being picked up by the fintech lenders."