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The Federal Reserve Bank of Cleveland has released a new research paper titled Three Myths about Peer-to-Peer Loans, in which it warns that problems in the US peer-to-peer (P2P) market are already 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,” the bank said. “Such a signal calls for a close examination of P2P lending practices.”
The Fed used a comprehensive set of credit bureau data to examine P2P borrowers, their credit behavior and their credit scores and 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.
“Overall, P2P loans resemble predatory loans in terms of the segment of the consumer market they serve and their impact on consumers’ finance,” the bank concluded.
“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.”
P2P lending came to the United States in 2006 and has grown considerably in recent years.
Back in 2009, P2P balances in the US were hovering around $45 billion. They more than doubled to just over $100 billion in 2016. The rise has coincided with the number of Americans with personal loans, from around 10 million in 2009 to almost 110 million last year.
The Federal Bank of Cleveland noted that while P2P lenders do not yet claim a significant share of the US retail financial market, the significance growth rates of P2P origination volumes and the rapidly expanding P2P customer base indicate that online lenders have the capacity to represent a “formidable market force” in the near future.
“The evidence we document, combined with the fast growth of the P2P market, suggests that the P2P industry has the potential to destabilize consumer balance sheets,” the bank said.
“Consumers in the at-risk category—those with lower incomes, less education, and higher existing debt—may be the most vulnerable. The overall performance of P2P loans strikingly resembles that of the subprime mortgage market before the 2007 subprime mortgage crisis.”
The bank said there are currently no regulators that oversee America’s online lending marketplace and its players.
“It might be time to look more closely at P2P lending practices and evaluate their implications for consumer finance.”
In Australia, the federal government has made clear its desire for more alternative lenders in the market.
Treasurer Scott Morrison has introduced legislation to lift the prohibition on the use of the word ‘bank’ and is eager to see Australia move towards online lending models that have grown popular overseas.
Speaking at the Financial Services Council in Sydney on Monday, 30 October, the Mr Morrison pointed to the UK, where authorities similarly removed the prohibition on the term “bank”, which led to a flood of new online lenders into the market, forcing the major banks to slash their interest rates and product pricing.
“Almost 60 new banks have piled into the UK market since regulatory changes in 2013, including digital banks like Monzo, Tandem and Starling — banks that sell themselves as ‘mobile first’,” Mr Morrison said.
“The future of our banking sector, under this similarly reduced licensing burden, is rather exciting.”
[Related: Government announces mandatory credit regime]