A Revolution in Progress: Regulating P2P Lending Platforms
Moran Ofir – The Interdisciplinary Center Herzliya;
Ido Sadeh – The Interdisciplinary Center Herzliya
-- Peer-to-Peer (P2P) lending typically refers to online marketplaces where lenders lend to individuals or small businesses. This new market segment originally designed to match retail lenders with borrowers, without the involvement of traditional intermediaries like banks, providing an alternative source of credit to individuals and enterprises, and a new asset class to lenders. For years, commentators viewed this growing industry as an ultimate example of disintermediation and emphasized its potential to democratize financial markets and mitigate the dominance of institutional actors in financial markets. However, in our new Article, A Revolution in Progress: Regulating P2P Lending Platforms, we take a closer look at the current state of this market and show that much of these views currently do not hold.
First, P2P lending platforms are no longer simple marketplaces that only match lenders with borrowers. Far from it, over the years they have gradually evolved into new financial intermediaries that perform various brokerage activities (e.g., loan screening and pricing services) and provide various tools intended to help lenders manage their credit risks (e.g., internal secondary markets, contingency funds, and auto-investment tools). Second, while P2P lending platforms were originally designed to serve retail lenders, they increasingly opened to institutional lenders who currently finance most of their loans (in the US). Finally, the P2P lending industry became more complex, with increasingly diverse types of business models, each involves different risks and challenges.
In our Article, we analyze the regulatory implications associated with these new conditions of the market and propose potential regulatory responses that better correspond to the current conditions of the market. We begin with the re-intermediation of platforms. P2P lenders became extremely passive over the past years, delegating essentially all tasks related to loan evaluation and pricing to platforms. This process, in which the platforms assume more and more financial intermediary functions, reduces lenders’ transaction costs and may benefit lenders since platforms are skilled, and hence can produce better outcomes in loan evaluations. On the other hand, however, it exacerbates the misalignment between lenders’ and platforms’ incentives: platforms perform all tasks related to the evaluation of loans but lenders absorb (almost) all the credit risk associated with these loans. Regulators should pay close attention to this exacerbated misalignment and consider measures to ensure the quality of the loan assessments provided by platforms.
Another regulatory issue discussed in our Article is the disclosure requirements imposed on P2P lending platforms. P2P lending platforms are subject to extensive initial and ongoing disclosure provisions, requiring them to disclose information about their business, service, past performance, etc. Yet, despite the heavy disclosure requirements, commentators seem to be dissatisfied with the level of transparency in the market and tend to highlight the need for a more effective disclosure. In our Article, we suggest that one possible reason for the limited effectiveness of current disclosure provisions is that they fail to take into account the differences in different platforms. As a solution, we propose imposing disclosure standards tailored to the characteristics of different types of P2P lending platforms and discuss some specific examples.
Finally, our Article discusses the key concerns associated with the entrance of institutional lenders: adverse selection among different types of lenders and growing financial stability risks. Our Article takes a balanced approach and suggests that while regulators should pay close attention to the adverse selection problem among lenders, which is backed by empirical evidence, the financial stability concern is presently less of an issue for a few reasons: (1) in most jurisdictions P2P lenders and borrowers’ funds are managed in segregated accounts, thus in the event of insolvency lender funds should not be affected; (2) P2P loans typically have a maturity of a few to several years, meaning that they are not used to support liquidity; and (3) P2P lending platforms do not take deposits or perform maturity transformation, and hence the risk of a bank run is not a concern.
The Article is forthcoming in NYU Journal of Law & Business.