Marketplace Lending and Asymmetric Network Effects
With the rise of giant platforms such as Alibaba, Amazon, and Apple, two-sided markets play increasingly important roles in the digital economy. Earlier studies typically focus on pricing and on one or two non-financial platforms. We know very little about the cross-section of the industry, the dynamics of struggling or failing platforms, and the distinction between emergent financial platforms and conventional marketplaces.
This situation starts to change with the rise of marketplace lending, also known as P2P lending or non-bank credit. LendingClub and Prosper are now household names in the United States; in China, thousands of P2P platforms emerged over less than a decade. Again, existing studies speak little about the industry evolution, despite that FinTech platforms represent a more and more significant fraction of the economy and their failures raise concerns about financial stability.
Our recent paper, “Survival Scale: Marketplace Lending and Asymmetric Network Effects” (jointly with Qi Miao), provides novel insights into these issues. Utilizing a novel data set of over a thousand Chinese P2P lending platforms, we first show that platform scale measured by trading volume has strong forecasting power on platforms’ future survival or failure because a larger scale corresponds to better matching efficiency and greater diversification of credit risks. This also holds when we use platform’s rank in the industry based on scale. We then show that platform scale is in turn driven by cross-side network effects---the elasticity of the number of new trades participated by agents on one side to the active number of agents from the other side of P2P platforms. We are among the first to construct such time-series measures to analyze platform cross-side network effects using large-scale panel data.
In particular, we find that failed platforms have cross-side network effects (CNE) lower than those of healthy platforms. Moreover, the lenders’ CNE is more predictive of platform’s survival than borrowers’ and the effect is stronger during the initial growth stage of platforms. There are thus two asymmetries. First, increases in lenders’ participation lead to subsequent increases in borrows’ participation. The lenders’ CNE dominates borrowers’ in determining a platform’s survival. Second, the influence of CNEs are significantly smaller when the number of users decreases than when it increases. We further show that the initial lenders’ CNE can be used to predict platform survivals and failures.
We argue that the interaction between CNEs and financial frictions on P2P lending platforms contribute to these empirical observations. First, financial platforms typically involve a long-term contract, unlike other platforms that involve more transactional activities. Because borrowers do not always adopt multiple platforms and platforms may fail, investors diversify their risks by investing in projects across platforms. In contrast, borrowers have no borrowing risk to diversify, face elaborate application and background check, and lose the reputational capital accumulated when switching platforms.
Consequently, lenders are easier to attract once borrowers join the platform, making lenders’ CNEs more important; if a platform can attract more borrowers with the same increases in lenders, it tends to grow faster. Furthermore, borrowers respond less when lenders are leaving because borrowers are on the receiving side and are less worried about platform failures. Informational frictions and the lack of a well-established credit reference system also implies borrowers are less willing to depart from the declining platform.
Our findings have implications for platform owners, investors, and regulators. Platform owners, for example, should aim for acquiring more borrowers, especially on nascent platforms. Regulators can potentially disclose information on platform scale and CNE to guide and protect retail investors. They also fill in a gap in the empirical literature by documenting the dynamics of declining platforms and formalizing a variant of practitioners’ concept of platform stickiness.
Finally, we note that marketplace lending in China is particularly suited for studying two-sided financial platforms. FinTech has the biggest impact in emerging economies where traditional financial sectors are less developed. But emerging markets also tend to have less developed legal systems and greater contracting frictions. The Chinese P2P market therefore remains a fertile ground for future research on non-bank credit and the industrial organization of platforms.
Lin William Cong – Cornell University
Ke Tang – Tsinghua University
Danxia Xie – Tsinghua University