A crushing blow to peer-to-peer lending dreams (updated)

Economists at the Cleveland Fed have published an excoriating bit of research that knocks down three of the key claims of “peer-to-peer” lending advocates.

We haven’t looked at US P2P lending in a while — it’s more commonly called marketplace, or online lending these days* — but the important thing to remember is that the sector has long been dominated by institutional loan investors, has historically relied on direct mail marketing for much of its growth and has always argued that it helps consumers consolidate their debts and get on a better financial footing.

It’s that last part at which Yuliya Demyanyk, Elena Loutskina, and Daniel Kolliner take aim. In their paper published last week, the researchers use credit bureau data to construct a sample of 90,000 people who took out a P2P/marketplace/online loan between 2007 and 2012, and compare it with 10m people who didn’t take out those sorts of loans. The results are not good for proponents of the sector.

The first question they ask is is, “Are P2P loans used to refinance previous loans?” Well, maybe, except:

On average, the non-P2P debt balances of P2P borrowers grow about 35 percent more than those of non-P2P borrowers within two years of the P2P origination year.

And in addition:

P2P borrowers exhibit a 47 percent increase — rather than a decrease — in their credit card balances after obtaining P2P credit as compared to matched non-P2P borrowers.

Then they look at whether the use of P2P loans helps consumers build their credit history. Nope again:

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.

And finally, perhaps the most interesting question, are P2P lenders serving people who don’t otherwise have access to credit, i.e. the unbanked?

Well, for one thing, the trio found that 34 per cent of P2P borrowers “increase their credit card balances at the same time as they obtain a P2P loan”, which is 10 percentage points higher than for non-P2P borrowers, and that 10.5 per cent take out a traditional instalment loan along with their P2P one.

Then they did an analysis of ZIP codes “that attract P2P lending” (our emphasis):

We find that the residents of P2P zip codes indeed have, on average, lower incomes and lower credit scores. P2P zip codes have less-educated and more racially diverse populations. Potentially, these characteristics could indicate that these areas are indeed underserved by traditional banks. However, the results also show that P2P credit is flowing into zip codes in which borrowers tend to have higher, not lower, debt-to-income ratios, and there are more bank branches and fewer individuals without credit cards in these areas. These facts indicate that the residents of P2P zip codes do have access to the traditional banking system and have previously obtained credit; thus, they are not likely to be unbanked.

When we zoom in on the P2P zip codes and compare the P2P and non-P2P borrowers who live within them, we once again observe that P2P borrowers are characterized by lower income levels, lower credit scores, and a higher number of delinquencies. These borrowers are more likely to be African American and not have a college degree. At the same time, P2P borrowers’ levels of debt-to-income ratios tend to be similar to non-P2P borrowers’. This evidence once again indicates that P2P borrowers are unlikely to be underbanked but are likely to be overleveraged even prior to obtaining their P2P loans.

The conclusion Demyanyk, Loutskina, and Kolliner draw from all this is fairly dramatic. On the whole, people who take out P2P loans are sliding deeper into debt, damaging their credit scores and are more likely to be non-college educated than neighbours with similar debt-to-income levels who don’t take out the loans.**

What does all that amount to? The researchers say: “Overall, P2P loans resemble predatory loans in terms of the segment of the consumer market they serve and their impact on consumers’ finances.

*I’ve used P2P in post because the researchers do.

**This sentence has been amended.

Update, 19th November:

On Saturday, 18th November, a spokesperson for the Cleveland Fed said it had removed the research from its website pending revisions:

Since working paper no. 17-18 and related commentary on peer-to-peer lending were posted on our website on November 9, the authors have received several questions about the composition of the underlying data set they used in their analysis. In light of the comments received, the authors are currently revising their paper to further clarify the data sample they used in the study. Their revised paper will be posted as soon as it is completed.

Earlier in the week, Ezra Becker, senior vice president and head of research and consulting at TransUnion, whose data was used in the study, had criticised the research:

It appears the research included some TransUnion data made available to the Federal Reserve Bank of Cleveland for an earlier research effort. However, we did not provide any approval for the use of our data in this study.

None of the TransUnion data provided to the Federal Reserve Bank of Cleveland at any time distinguish between P2P loans, FinTech loans more broadly and traditional personal loans. Consequently, we do not understand how the Federal Reserve Bank of Cleveland researchers arrived at their conclusions based on any of the data TransUnion previously provided.

Becker added that TransUnion’s “results regarding the impact of FinTech loans do not align with those of the Federal Reserve Bank of Cleveland, and in fact contradict their conclusions.”

Related links:
A sit down with Adair Turner, where the former FSA chairman doubled down on his concerns about the sector – FT Alphaville
Moody’s rains on the online lending parade — FT Alphaville
Unanswered questions in online lending — FT Alphaville
Lenders can’t discriminate, but what about investors? — FT Alphaville
LendingClub comes up short as it cuts back full-year guidance — FastFT

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