Are P2P Loans Actually “Predatory”?
A new report released by the Federal Reserve Bank of Cleveland is causing waves in the FinTech community as it makes some harsh claims about the practice of peer to peer (P2P) lending — also known as marketplace lending. Among those assertions is the idea that P2P lenders engage in predatory practices, with the report stating, “P2P loans resemble predatory loans in terms of the segment of the consumer market they serve and their impact on consumers’ finances.” Naturally this quote and the report’s “Three Myths about Peer-to-Peer Loans” headline have been grabbing attention, but what are these claims based on and what do they really mean?
P2P Loans vs. Credit Card Interest Rates
The first “myth” that the Federal Reserve looks at is the notion that the majority P2P loans are used to refinance existing loans and credit card debt. As the report points out, peer to peer leader Lending Club says upwards of 80% of their borrowers use loans to refinance or consolidate. However the Cleveland report claims that, according to their data, not only might those borrowers graded with a ‘C’ or ‘D’ by Lending Club be paying more for a loan than on a credit card but that their debt actually rises after securing a loan. This would suggest that, if borrowers do pay off their credit cards with a P2P loan, they’re continuing to run up more debt afterward. Furthermore, while the report notes that the lower-rated loans don’t compare favorably to the average credit card interest rate, it’s unclear if that average is adjusted to reflect the less than prime nature of the borrowers they’re discussing.
P2P Loans Effect On Credit Scores
Speaking of credit, the next topic the report looks at is whether P2P loans help borrowers build their credit history and raise their scores. Beyond the positive effects of paying down debt, peer to peer loans have been said to help borrowers boost their credit by turning their revolving debt into an installment loan, likely helping their credit mix. But, once again, the Cleveland report found many borrowers failed to improve their credit after taking out a P2P loan, instead proceeding to increase their delinquencies and tarnish their scores. The report states, “Our results suggest that the credit scores of P2P borrowers fall substantially and delinquency rates rise after taking on a P2P loan compared to non-P2P borrowers. We also discovered that numerous measures of derogatory events (number of past due accounts—both revolving and installment—and number of bankruptcies) significantly increased for borrowers who took out P2P loans. These results indicate that P2P loans have the capacity to worsen borrowers’ prospects for future access to financing.”
Market Access to Loans
The final claim the report looks at is whether peer to peer lenders help server underserved markets access capital. To assess this, the Federal Reserve decided to “compare access to traditional loans by P2P borrowers and matched non-P2P borrowers.” However even they acknowledge it is “somewhat tricky” to pull this off effectively, but nonetheless concluded that peer to peer borrowers are unlikely to be underbanked. Furthermore they assert that borrowers are likely to be overleveraged even before applying for a loan.
So What Is the Impact of Marketplace Lending?
Concluding their report, the Federal Reserve Bank of Cleveland states, “It might be time to look more closely at P2P lending practices and evaluate their implications for consumer finance.” Interestingly, some in the FinTech sector are suggesting critics take a closer look at the Cleveland report itself. In fact, Nathaniel Hoopes of the Marketplace Lending Association told Bloomberg, “Despite the misleading title, this not a study of marketplace lending, which only makes up a small percentage of the data.” Additionally Hoopes notes that a recent report released by the Federal Reserve Banks of Philidelphia and Chicago had some very different conclusions to Cleveland. Specifically, while the Cleveland report name drops Lending Club often, the Philly/Chicago report that looked at Lending Club found, “Given that credit spreads are priced accurately based on the expected delinquency of the loans, we found that for the same risk of default, consumers pay smaller spreads on loans from the Lending Club than from traditional lending channels, implying that FinTech lending has provided credit access to consumers at a lower cost.” Meanwhile elsewhere in the report it was discovered that, “Lending Club’s consumer lending activities have penetrated into areas that could benefit from additional credit supply, such as in areas that lose bank branches and in highly concentrated banking markets,” thus disputing another one of Cleveland’s three “myths.”
Ultimately there are a lot of questions raised by the Federal Reserve Bank of Cleveland’s report on P2P lending. Among them is the question of whether or not lenders are responsible for the financial actions of their borrowers once approving them, as the report seemingly blames Lending Club and other lenders for the potentially poor financial habits of their customers. Additionally, like the Marketplace Lending Association, some are questioning this report’s methodology and definition of P2P. Regardless of the actual answers, there’s no question that the headlines that have resulted from this report — fairly or not — will have a negative effect on the FinTech industry at a time when the sector is fighting to be taken seriously in the world of banking.
Also published on Medium.