Bill Kerr: Digital technology and artificial intelligence are bringing about new models of borrowing and lending. Fintech, the industry born from the combination of technology and finance, is simultaneously expanding access to financing and posing new challenges for customers and regulators.

Welcome to the Managing the Future of Work podcast from Harvard Business School. I’m your host, Bill Kerr. Today I’m speaking with Karen Mills, a professor at Harvard Business School and a former member of President Obama’s Cabinet as head of the US Small Business Administration [SBA]. In her new book, Fintech, Small Business & the American Dream, Karen explores the implications of modern financial technologies for small business, a category which employs about half of America’s workforce. Building on her expertise, she highlights the new opportunities fintech is providing to small businesses and concerns that must be addressed. Welcome, Karen.

Karen Mills: Delighted to be here, Bill.

Kerr: Karen, tell us a little bit about the book. Why write this book? What are the themes that you’re bringing out?

Mills: Ten years ago, right at this time, I had the great honor of going to work for President Obama as the head of the Small Business Administration. The problem was that 10 years ago, we were in the middle of a huge financial crisis. And this financial crisis was caused by a credit crunch. Banks had stopped lending because they’d gotten overextended with mortgages. But that turned out to be a really devastating moment for small businesses. My first quarter in office, we lost 1.8 million small business jobs. Why? Because small businesses depend on credit. They depend on access to bank credit, mostly, for cash flows for their businesses. And when that dried up and froze, many small businesses suffered and went out of business. So I really learned a lesson at that moment. Small businesses are important to the American economy, but access to credit is critical for small businesses. And that led to really the writing of this book.

Kerr: You’ve done a very careful job of separating what’s a Main Street business vs. supply-chain type business. Walk us through a little bit of that and then how these different types of small businesses will be affected by this future.

Mills: Half the people who work in this country own or work for a small business. And, actually, two out of every three net new jobs come from small businesses. But it turns out, all small businesses are not the same. There are 30 million small businesses in this country; 24 million of them actually have no employees. So this is part of the gig economy and the sole proprietors. That segment is, of course, growing. In addition, a lot of the jobs in the small-business sector are in a sector we call “Main Street.” So these are local businesses—car repair, dry cleaner, local restaurants—and they sometimes get overlooked because macroeconomists say, “Well, these don’t really fit in my equation. They’re not very important.” But they actually create a lot of the jobs, they’re the fabric of our community, and they are the way we have economic mobility. My grandfather came to this country, started a business, and provided for his family, grew his wealth to be able to live the American dream. We need to make sure that those businesses who rely on banks have access to capital and a whole set of other things so that they can grow and create jobs.

Kerr: Yeah. The recovery from that financial crunch took a long time to unwind, especially for small businesses.

Mills: It did take a while. And we took some pretty aggressive action at the time. Larry Summers, who was the head of the National Economic Council, and President Obama allowed me to do something pretty bold. I was a venture capitalist. I came into government. I thought, “Well, we have to do something to solve this problem.” At the SBA, we raised the guarantee rate on SBA loans to 90 percent. And we eliminated all the SBA fees. I’m pleased to say we got 1,000 banks back to SBA lending in six months. And that experience really brought home the notion that, if they hadn’t had this access to the banks and the capital, they would not have survived. So now we fast-forward to this moment, where even though we had a slow credit recovery, something happened in the meantime, in the five or six years since I left the SBA. I have been tracking how technology is changing this lending environment. And it turns out, it’s going to be pretty dramatic.

Kerr: Tell us a little bit about the technologies that you’ve been following and what you’ve keyed in on.

Mills: The first thing that happened is we thought we were on another rise. Fintechs came onboard about 2010, and there are new companies that came in. And what they did is use technology to change the pain points of the small-business experience in lending. Getting a loan for a small business was a matter of Xeroxing a pile of paperwork, walking down the street to a bank, giving it to the loan officer, and the loan officer spent weeks, maybe months, figuring out if that small business really was creditworthy. Very hard to tell. We call this “information opacity.” You just don’t know what’s going on inside a small business. Turns out, data has the ability to change that game. In the early fintechs, we thought they were just going to all take off. We called this the “Wild West.” They were going to have 70 percent of the market. Not so fast, because what they brought in the first wave of technology was just a better customer experience, which was a good thing. Then the banks woke up. J.P. Morgan decided, “I am not going to cede this market to the new upstarts.” And Amazon, PayPal, Square, they all came into the market as well. So now we’ve got a very rich environment of competition.

Kerr: And this sort of paperwork that you describe is one of the reasons that small-business lending can be hard; that, if you are one of these banks, you have to spend a lot of time going through that paperwork, even if it’s a $50,000 loan to the potential restaurant or if it’s a $50 million loan that you’re providing to a bigger business. So tell us a little bit about that constraint that’s on the banking side.

Mills: What we saw in the recovery, as you pointed out, it was a very slow reentry of the banks into lending. And market gaps started to appear, particularly in small-dollar loans, because for $50,000, it just wasn’t worth it for a bank to go through all that paperwork and figure out if you were creditworthy. And for a $10,000 or $7,000? Definitely not worth it. Technology has the ability to really take cost out of that process and maybe even add intelligence. If you take a whole set of data about a small business—what’s in their bank account, what they spent on credit cards, what went through their Square payments processing—you might be very much smarter than if you just look at their credit score and their tax returns. So now we’ve got the ability to maybe use artificial intelligence and have a much quicker process and maybe a more complete and intelligent process than when the person was filling out the forms.

Kerr: Tell us what you envision could be out there for small business, which, again, is about half of our economy—so a significant chunk of our workforce and our businesses. What could lie around the corner for them?

Mills: I just spent a lot of time on the West Coast talking to a whole set of people—Square and Plaid and some of the players in the fintechs. If you have different APIs—application programming interfaces—that suck up all the data from these various data sources and put it into an intelligent algorithm, that does one thing I just talked about, which is making the underwriting and credit process more seamless, maybe more intelligent. It has a second effect, which is that same intelligence, that same data, could inform a small business about its future cash flows. It could create a dashboard where a small business could see, “Oh, my gosh, in three weeks, I’m going to need $4,000 in order to meet payroll. But after that, the seasonality will come back, and I’ll be able to be cash-flow positive.” Knowing that for a small business is really game-changing.

Kerr: Very valuable, yeah.

Mills: So I call this “small-business utopia.”

Kerr: And there’d be some sort of ability also to click a button, maybe get a [revolving loan] or something like that to cover that $4,000 shortfall until you’re back into the seasonal upswing.

Mills: Exactly. Wouldn’t it be nice if on this dashboard there was something that said, “Press here if you want to borrow that $4,000. Oh, by the way, you are preapproved.” The notion is that clouds of credit would follow the customer in the environment of the small-business dashboard and the whole lending and service environment, and that’s not so far away, either, because we already have this on credit cards: “You are preapproved for a line of credit.” That tends to be quite expensive. So the idea is that you would be able to use this dashboard to understand your needs. Do you need a loan? How much? What duration? What’s the cost? And then you would be able to—right on that dashboard—get loan offers, press the button, and get the money in your account the next day.

Kerr: So, Karen, with this new artificial intelligence and other advances, does lending actually become better inside the banks?

Mills: We want to make sure all creditworthy small businesses get access to capital. But what about if a small business is creditworthy, but there’s some kind of barrier or friction in the traditional lending market that prevents that small business from being seen and understood? We actually know these gaps exist, particularly for women- and minority-owned businesses. One of the reasons I know is, in the SBA portfolio, women and minority businesses provide a disproportionate amount of the loans that we gave. Why? Because the SBA is supposed to fill market gaps. It’s supposed to give a loan to a business that a bank wants to support but just can’t get there. We know that most of these loans are actually good ones. Ninety-five percent of the SBA loans pay back. The loss rate’s under 5 percent. So here you have a large proportion of women- and minority-owned businesses we know are creditworthy, but the current market is not getting the capital to them. The hope is that technology will enable a more transparent look into their business, and they will have success.

Kerr: So [not] just more accurate lending but also fairer lending.

Mills: Now, fair lending is the positive outcome. There is a dark side to the black box. There is a lot of concern that the algorithm will learn on past behavior and will create bias inside. And, in fact, one imagines that might be true because a machine learns based on the data that has discriminated: In this ZIP code people don’t usually pay back their loans; therefore, we should not make a loan in that ZIP code. Then we’re back to redlining right away. One of the critical challenges for regulators and for the businesses that is creating these algorithms is to figure out how do we look inside the algorithm and determine whether there is bias? This is hard to do but not impossible.

Kerr: And as you talk to the startup companies that are trying to make this into reality, did they say any frictions that they’re facing or any potential hiccups that wasn’t so obvious with this dream of the future?

Mills: Well, it turns out that there is a whole set of barriers and frictions that are coming at this utopian view. And, of course, these reside in Washington in banking regulation. Now, I have two chapters in my book about regulation. And I know that puts everyone to sleep. But it turns out that getting the regulation right around this new small-business lending environment is critical. Banking is a highly regulated activity. And it should be, because we’re taking customer deposits, so that should be regulated.

Kerr: People’s money, yeah.

Mills: We are insuring it with taxpayer insurance through the FDIC and others. And we also have data-security issues, because we’re going to be putting your personal bank account data in between technology platforms and your bank. So these third-party arrangements should be subject to regulation. The problem is, right now, we have what I call “spaghetti soup.” We have seven regulators, all of whom have various jurisdictions and rules, and it makes it very, very difficult for fintechs and banks to partner. It makes it difficult for innovation to take place. So how do we straighten this out? And it turns out that the answer is not less regulation. It’s what I call “smart regulation.”

Kerr: And this sounds like a spaghetti soup that goes beyond just small business. Would this be more broadly true? Or it’s something that’s particularly sharp about this spaghetti soup for the small-business lending sector?

Mills: There is something particularly onerous about the lending environment for small businesses. And this is a pet peeve of mine, I have to admit. Small business has kind of fallen through the cracks in the regulatory environment, despite the fact that there are these seven regulators. For instance, some of the protections on lending that apply to consumers don’t apply to small businesses. So if I buy a truck for my snow removal business, I am not protected. But if I buy the truck as a consumer, I get a whole Schumer box that tells me exactly how much the loan costs. Well, that just seems to me dumb. We ought to be protecting small-business owners and informing them. We already do it for consumers. How much harder can it be?

Kerr: Having spent many years as the Administrator for the SBA and in the Cabinet, you will know something about—mixing metaphors here—I guess navigating the swamp that is producing the spaghetti soup. What is the smart regulation, and how do you envision that being able to come to fruition?

Mills: I just spent a lot of time with a lot of our regulators. And I have to compliment them. They are thinking very hard about all of these points. But one of the issues is that, who is going to take the lead? The Administration or Treasury could take the lead in sort of setting the guidelines here. Congress could take the lead, although they have a lot of trouble executing at this moment. But I believe that the regulators need better form to get together. I think this may begin to happen under a new set of questions that are coming up, mainly driven by people like Facebook. The question is: Who owns your data?

Kerr: A rather large question out there right now.

Mills: It’s out there. And I said to the regulators the other day, “You need to be ahead of this question, because it’s already arrived.” In Europe, they have made a decision about who owns the data. And this comes under a set of privacy regulations that have already been implemented in Europe. And the UK took these regulations even one step further. And the name of it in the UK is called “Open Banking.” And what it basically means is that you can permission an entity, a fintech, some kind of provider of service to you, to get all your bank account data, and then they can use it to make a decision about giving you a loan or anything else. We need to think about here how we implement open banking. My recommendation is that we need to be clear that customers own their data. Why? Because that will allow innovative platforms to access the data, build the algorithms, and then that set of intelligence can be used by all kinds of players—banks, other fintechs, tech companies—to provide you with better products and services.

Kerr: Now, in Washington there’s obviously a lot of lobbying that goes on. Is there a group that has a vested interest in not moving toward this open banking or toward the kind of broader business environment that you envision for small business?

Mills: Banks have tremendous lobbying power in Washington, both community banks and banks in general. And this has, I think, put the brakes on a lot of the progress that we need to make on regulation. My view is that we need the banks and the regulators to lean in together, realizing that the new landscape of the future is not threatening for them if they start to implement smart regulation. Quite the contrary, this is the platform to make banks successful in the new environment.

Kerr: And you talk about in there a bunch of different types of banks—ranging from the J.P. Morgans of the world down to community banks. If you’re a small community bank right now, should you be terrified of this AI future? Should you be embracing it? How do you think of this shaping out in terms of the industry structure?

Mills: I’m a big fan of community banks. This comes from the experience at the SBA and seeing the kind of good they do and seeing the important relationships they have with small businesses. But without any bias, I actually believe that the new landscape could favor the community bank, because—once again, walk with me into the future that I have imagined—what if we had all of these technology products that I’ve described? We have the small-business dashboard. We have underwriting algorithms. And they are all contained easily in a technology infrastructure that a community bank can access. Well, now the relationship manager has a different kind of work to do. Instead of that long process where they get the paperwork and fill out the forms and try to understand what’s going on inside the small business, they and the small business owner have the dashboard. The lender knows whether the small business is creditworthy. The small business, themselves, knows whether or not they want to take that loan and how they might pay it back. So that gives them more confidence. And they can have a real conversation with that relationship at the core. And the community bank is also providing the bank account and transaction processes around the small business owner. So I think that local community bank relationship banking feeling is actually enhanced by technology, and they should embrace it. They shouldn’t be sitting back in their chairs with their heels dug in getting dragged forward. They should be leaning forward and trying to encourage the regulators to get this smart regulation going.

Kerr: It sounds like you’re also bullish on the overall number of jobs that will be in this sector—that we’re not going to go to some perfectly automated banking future where there’s no employment in the banks.

Mills: I think there’s still a role for the relationship banker and maybe an even more enhanced role for the relationship banker. I did a case on Eastern Bank, where Bob Rivers, a terrific CEO here in Boston, one of the most important small-business lenders, decided that running a 200-year-old community bank was no reason not to innovate. And he brought inside a whole set of innovative fintech people. They created a product, sort of what I’ve described, that allowed a community bank to do automated small-business lending. And then they spun that product out to be available to other community banks. So this is already a platform where they can enhance their ability to grow and create jobs and even open branches, because they’ve got the technology infrastructure. So I think it could be at least a job enhancer, if not a job creator in the banking sector.

Kerr: Yeah, having taught that case, one of the things I found most interesting was how early on—even though Eastern has been in Boston for 200 years—the CEO, Bob Rivers, and his team had to think about how to find their way a couple miles down the road to the Cambridge Innovation Center or to other parts of the Boston area where the fintech advances were happening. So they had to, even being situated in our city, be able to find their ways to the pockets of knowledge.

Mills: This is a critical issue for our moment of fintech transformation and really technology transformation. It is a little bit hard to access an understandable approach to technology if you’re a traditional company or a traditional bank. So Bob did actually walk around the streets just meeting fintech people. One of the things that organizations like the Community Banking Organization can do is provide better conduits. And this meeting between the old world and the new technology world, I think, creates a lot of rough edges at the moment. But I believe that it will get easier and easier.

Kerr: Any advice for the young entrepreneur, the young banker out there who’s trying to think about this fintech future, what they should be doing to position themselves in it?

Mills: I believe that all of the technology we’re seeing—the ability to bring in a lot of data to analyze it, to use artificial intelligence—I believe that all of these activities will have an impact first, perhaps, in the financial services sector. Before we get driverless cars and a lot of these other things, we’re going to transform banking. And I think this creates a huge set of opportunities for people in an industry that was, perhaps, not as entrepreneurial and more traditional. So I would say to a young entrepreneur, either look in the fintech space and see how you can operate, or even look in the traditional banking space, because we can reinvent the wheel here. We can make sure that we have a whole new way of providing products and services. We can overcome these barriers and frictions that we’ve had in this sector and make more prosperous activity for bankers. But the real joy is that all this will benefit small-business owners. Small businesses really are the way in this country we create access and opportunity. It creates so many jobs. And so, often, even though people say small business is the backbone of the economy, we aren’t doing enough for our small business community. With technology, I think we have the chance to transform that landscape and create small business utopias, create products and services that make more small businesses succeed, and I think that will be good for America.

Kerr: And with more than half of our employees in that sector, that’s very important for the future of work.

Mills: I think the future of work may, in fact, be more like the future of Main Street. Main Street will be the place that you come for community. And we want to make sure our Main Street merchants and our small businesses have a big place in that future.

Kerr: Karen, thank you for sharing some of your insights. And your book again is Fintech, Small Business & the American Dream. We highly recommend everyone pick up a copy. Thanks.

Mills: Thank you.

Kerr: And thanks to all of you for listening in.