Funding Decisions in Online Marketplace Lending
Chris.K.C. IP - Hong Kong Institute for Monetary and Financial Research;
F.Y. Eric LAM - Hong Kong Institute for Monetary and Financial Research
-- Online marketplace lending is a financial technology that utilizes web and mobile applications as the channel to bring together individual borrowers and lenders. Such online peer-to-peer platforms typically focus on personal loans that are unsecured, thus the proposed and funded loan amounts per loan application are not large. However, given the enormous volume of participants and loan listings, some see this lending channel developing into an emerging debt market. It is also noticed that a significant portion of the upcoming virtual banks in Hong Kong are keen on this mode of business. Although there are numerous studies touching upon this financial technology, no paper has examined how funding decisions are made in this market.
To address this issue, our study entitled “Funding Decisions in Online Marketplace Lending” analyzes more than 28 million recent loan listings on LendingClub, the world's largest online consumer lending platform operating in the US. Our data set contains rejected applications together with approved ones. We use the simple decision tree algorithm to classify funding decisions (fund vs reject) from all available loan listings. Under this framework, we shed light on the lending preference of a representative investor. The impact of the monetary policy regime on funding decisions is then investigated.
The estimated funding decision structure achieves high accuracy in- and out-of-sample. Among all available variables, we found that employment length, a proxy for borrower's income stability, is the dominant factor in determining funding outcome. Lenders prefer borrowers with longer employment, i.e., arguably stabler income. Attributes such as requested amount and debt-to-income ratio are secondary while borrowing purpose is almost trivial.
Why employment length? The literature on online marketplace lending tends to have a consensus that loan substitution is the main financial activity on online peer-to-peer lending platforms. As refinance is widespread on these platforms and such phenomenon is persistent across time, it would be legitimate for potential lenders to believe that refinance is the inherent motive for borrowers. If the requested loan is used to replace older debt obligations, the funding should not worsen the borrower’s financial health.Instead, it may even improve the borrower’s financial well-being if the new loan provides better terms such as lower interest rate and/or longer maturity. Hence, the requested amount, the debt-to-income ratio and the “borrowing purpose” would not be the major concerns for lenders. In this circumstance, the sustainability of the borrower to continually service her existing financial obligations should be the most important concern. We argue that this explains why employment length is the major factor in determining funding outcome.
To examine the passthrough of monetary policy to this debt market, we introduce a monetary policy regime indicator as well as the Fed target rate into the funding decision structure. The results suggest that monetary policy has little influence on the funding decisions in online marketplace lending.
The implication of our findings is nontrivial. Given the role of conventional prudential measure, e.g., debt-to-income ratio, and monetary policy shown above, central banks and regulators might find new challenges in supervising online marketplace lending market than the traditional ones. As this debt market is becoming more prominent, the share of fintech lending platforms in unsecured consumer loan business might catch up or even exceed that of banks and other traditional lending intermediaries. Thus, more attention is worthwhile as financial technology penetrates the capital market.