Written by the Cleveland Fed

Peer-to-peer lending platforms, which provide a way for individuals who want to invest to lend to those who want to borrow, have experienced phenomenal growth in the past decade. Many praise the industry and maintain that P2P loans provide unique benefits to consumers. We examine a comprehensive set of credit bureau data to examine P2P borrowers, their credit behavior, and their credit scores. We demonstrate there is little evidence of these benefits. In fact, P2P loans resemble predatory loans in terms of the segment of the consumer market they serve and their impact on consumers’ finances.

Peer-to-peer (P2P) lending came to the United States in 2006, when individual investors began lending directly to individual borrowers via online platforms. In the decade since, the industry has grown dramatically, and P2P lending is now widely regarded as the most progressive consumer finance innovation in financial markets today.

Online lenders and policymakers have suggested that the P2P market offers unique benefits to consumers. Three benefits are often repeated and seem to have become widely accepted. First, P2P loans allow consumers to refinance expensive credit card debt. Second, P2P loans can help customers build their credit history and improve their credit scores. Finally, P2P proponents claim that P2P lending extends access to credit to those who are underserved by traditional banks.

But signs of problems in the P2P market are appearing. Defaults on P2P loans have been increasing at an alarming rate, resembling pre-2007-crisis increases in subprime mortgage defaults, where loans of each vintage perform worse than those of prior origination years (figure 1). Such a signal calls for a close examination of P2P lending practices. We exploit a comprehensive set of credit bureau data to examine P2P borrowers, their credit behavior, and their credit scores. We find that, on average, borrowers do not use P2P loans to refinance pre-existing loans, credit scores actually go down for years after P2P borrowing, and P2P loans do not go to the markets underserved by the traditional banking system.[1] Overall, P2P loans resemble predatory loans in terms of the segment of the consumer market they serve and their impact on consumers’ finances. Given that P2P lenders are not regulated or supervised for antipredatory laws, lawmakers and regulators may need to revisit their position on online lending marketplaces.

From Peer to Peer to Institution to Peer

While P2P lending hasn’t changed much from the borrowers’ perspective since 2006, the composition and operational characteristics of investors have changed considerably. Initially, the P2P market was conceived of as individual investors lending to individual borrowers (hence the name, “peer-to-peer”). Yet even from the industry’s earliest days, P2P borrowers attracted institutional investors, including hedge funds, banks, insurance companies, and asset managers. Institutions are now the single largest type of P2P investor, and the institutional demand is almost solely responsible for the dramatic, at times triple-digit, growth of P2P loan originations (figure 2).[2]

The shift toward institutional investors was welcomed by those concerned with the stability of the financial sector. In their view, the P2P marketplace could increase consumers’ access to credit, a prerequisite to economic recovery, by filling a market niche that traditional banks were unable or unwilling to serve. The P2P marketplace’s contribution to financial stability and economic growth came from the fact that P2P lenders use pools of private capital rather than federally insured bank deposits.

Regulations in the P2P industry are concentrated on investors. The Securities and Exchange Commission (SEC) is charged with ensuring that investors, specifically unaccredited retail investors, are able to understand and absorb the risks associated with P2P loans.

On the borrower side, there is no specific regulatory body dedicated to overseeing P2P marketplace lending practices. Arguably, many of the major consumer protection laws, such as the Truth-in-Lending Act or the Equal Credit Opportunity Act, still apply to both P2P lenders and investors. Enforcement is delegated to local attorney general offices and is triggered by repeat violations, leaving P2P borrowers potentially vulnerable to predatory lending practices.

Evaluating Three Claims about P2P Lending

We investigate three questions: Are P2P loans used to refinance previous loans, do P2P loans help borrowers build a better credit history, and do P2P lenders serve individuals or markets underserved by traditional banks? To accurately assess these questions, we need to compare the behavior of financially identical people who differ only on one dimension, namely whether they took a P2P loan. That is, we need a sample of people with the same trends of incomes, debt, credit scores, and patterns of loan repayment before any of them took out a P2P loan. Some people in the sample have taken out a P2P loan and others have not.