Peer-to-peer (P2P) lending has grown exponentially in the last few years in both the U.S and UK. P2P finances loans to individuals or businesses by matching borrowers with investors. From almost zero ten years ago, the industry is now thought to be worth well over $30 billion. On the face of it, everyone’s a winner. The borrower gets access to cash, whilst the lender / investor gets a higher interest rate than through a traditional bank. It’s all done online and so costs are minimal. What could possibly go wrong?

For a start, these loans are generally unsecured, meaning that a default by the borrower will result in the lender losing their entire capital. In fact, defaults in P2P are beginning to edge up. Adair Turner, the previous chairman of the UK financial regulatory body has said that, “The losses which will emerge from peer-to-peer lending over the next five to ten years will make the bankers look like lending geniuses.” On the other side of the coin, there are many cheerleaders for this “fintech disruption.” In particular, proponents of P2P lending claim that it allows small borrowers to consolidate their debt and stabilize their financial affairs by, for instance, allowing them to pay off expensive credit card loans.

However, a recent report from the Cleveland Fed may well change attitudes in the P2P space. Researchers examined 90,000 P2P borrowers in the U.S between 2007 and 2012 and compared the data with 10 million borrowers who didn’t take P2P loans. They found 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.”

Moreover, when they took a deeper dive into the data in terms of zip codes, they found that those taking out P2P loans had similar debt-to-income ratios as their neighbors who did not use P2P, but that the P2P borrowers tended to be non-college educated African Americans. The report’s conclusion is damning – “P2P loans resemble predatory loans in terms of the segment of the consumer market they serve and their impact on consumers’ finances.”

This echoes the sub-prime mortgage debacle which kicked-off the financial crisis of 2008. Although perhaps unintended, financial innovation allows vulnerable borrowers to burden themselves with excessive debt. P2P is not (yet) big enough to cause any systemic failure if delinquency rates balloon, but it is one more sign of a society addicted to debt. P2P is sometimes referred to as crowd-lending. When debt deflation takes hold, it is likely that the crowd, as in the stock market, gets caught in the wrong place at the wrong time.

A recent photograph taken of a loan company advert on a London underground train. The APR – Annual Percentage Rate – is highlighted, bottom left.

Predatory Lending

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