Research shows disparity in borrower benefits between local banks and online lenders
Tuesday, July 27, 2021
The proliferation of online marketplace lending has been disrupting the consumer credit market, giving borrowers increased options for consolidating debt and building credit.
Although marketplace lenders like the Lending Club, Prosper and others can transcend the geographic boundaries of traditional banks, the ultimate benefits to marketplace borrowers can still differ because local opportunities to replace marketplace loans vary.
How do the competitive incentives of local banks drive the behavior and benefits of digital marketplace borrowers? Is there a disparity in the benefits enjoyed by consumers from online marketplace lending?
A research study by Purdue University Krannert School of Management professors Mohammad Rahman and Zaiyan Wei addresses those questions. The paper, “Where You Live Matters: Local Bank Competition, Online Marketplace Lending, and Disparity in Borrower Benefits,” was coauthored by Mohammed Alyakoob at the University of Southern California Marshall School of Business. It is forthcoming in Information Systems Research.
“Online marketplace lending has emerged as a credible substitute for conventional loan offerings,” Rahman says. “Despite their capacity to transcend geographic boundaries, however, the benefits that marketplace borrowers extract remains dependent on their banks’ competitive incentives to serve local borrowers. Their payoffs are still not immune to the traditional local market competition and geographic frictions present in the lending markets.”
This competitive dynamic also has implications for various stakeholders, including marketplace lending, the consumer credit market, and policymakers. “Mergers and acquisition discussions should not ignore marketplace borrowers in considering the impact on local consumers,” Rahman says. “Unless geographic frictions are removed, digital disruptions cannot equalize the benefits.”
Additionally, the research finds that the marketplace borrowers who live in markets that are more competitive are more likely to pay off their marketplace loans early in one large sum, indicating greater availability of favorable options locally. Ultimately, as local bank competition dictates the favorability of available loan terms within a geographic area, the online marketplace borrowers end up benefitting differently from the digital disruptors.
“We find consistent evidence that digital marketplace borrowers manage their loans differently based on the local banks’ incentives to serve local borrowers,” Wei says. “The subprime borrowers residing in competitive markets, particularly those previously unviable to local lenders, can benefit disproportionately from online marketplaces by borrowing from them and improving their credit scores.”
Initially, local lending markets might overlook these borrowers because of sub-prime credit and/or the fact that they carry more lucrative loan products from the same institution, such as credit cards that generally charge higher interest rates than personal loans.
“As these borrowers’ risk profiles improve, so does their creditworthiness to local lending markets,” Rahman says. “From a social equity perspective, that trend could also help narrow the wealth gap.”
Sources: Mohammad Rahman, mrahman@purdue.edu; Zaiyan Wei, zaiyan@purdue.edu
Full paper available at: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2985099