US warning: P2P loans look like subprime mortgages

  • By Elizabeth Fry
P2P lending

Loans made by the US peer-to-peer lending industry bear a striking resemblance to the subprime mortgage market before the 2007 crisis, the Cleveland Federal Reserve warned in a new report.

The research found that defaults on peer-to-peer 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.

The Cleveland Fed also called for a close examination of lending practices of marketplace lenders like Prosper, Lending Club and SoFi.

In the report, the researchers looked at three claims typically made about the industry - that it helps people refinance previous, expensive, loans; it helps borrowers build a better credit history; and that it serves the underbanked.

"These three benefits are often repeated and seem to have become widely accepted," the report's writers said.

Debunking myths

After scrutinising credit bureau data on peer-to-peer borrowers, their credit behavior, and their credit scores, the researchers discovered there was little evidence of these benefits.

The research found that, on average, borrowers do not use peer-to-peer loans to refinance pre-existing loans, credit scores actually go down for years after marketplace borrowing, and peer-to-peer loans do not go to the markets underserved by the traditional banks.

“In fact, peer-to-peer loans resemble predatory loans in terms of the segment of the consumer market they serve and their impact on consumers’ finances.

“Given that peer-to-peer lenders are not regulated or supervised for antipredatory laws, lawmakers and regulators may need to revisit their position on online lending marketplaces.

Further, the evidence - combined with the fast growth of the peer-to-peer market - suggests to the researchers that the industry has the potential to destabilise consumer balance sheets.

Analysis misleading

"Consumers in the at-risk category - those with lower incomes, less education, and higher existing debt - may be the most vulnerable,' the researchers said.

"And, while peer-to-peer lending is still a fairly small part of the overall retail financial market, its rapid growth suggests it could become a formidable market force in the near future."

RateSetter Australia chief executive, Daniel Foggo, expressed concern about the methodology used by the Cleveland Fed.

"By the US$100 billion of peer-to-peer loans, the report states as being outstanding, they are clearly classifying a large range of non-bank lenders as peer-to-peer lenders, so their analysis is somewhat misleading. 

“We know the actual number of actual peer-to-peer loans outstanding is a small fraction of this amount.

“In Australia peer-to-peer lend to prime borrowers, so even if there were any substance to some of the report’s findings for the US market, they would not be relevant to Australia.

“The Australian peer-to-peer lending market is more like the UK, where there is strong empirical evidence that the development of the industry has been of great benefit to consumers.”