FinTech and capital allocation efficiency: Another equity-efficiency dilemma?

The emergence of financial technology (FinTech) introduces new tools and solutions to lending and equity markets, and has significantly increased the accessibility of marginal firms to funds, a property known as financial inclusion. However, little is known about whether such inclusion is acquired at the cost of efficiency. This paper provides evidence on how FinTech affects the efficiency of capital allocation using firm-level data for China over the period of 2010-2020. The development of FinTech is measured as the number of FinTech firms in a city. We find interesting evidence that the growth of FinTech reduces the capital available to more efficient firms. The evidence stands robust at both the firm- and industry-level. We identify two mechanisms that can explain the inefficiencies of FinTech in capital allocation. The first mechanism involves FinTech-induced competition in the lending market, and the second explanation relates to the property of equity-efficiency dilemma of FinTech. Finally, we show that the inefficiencies of FinTech in capital allocation arise mainly from its impact on debt financing.