Consumer credit

Has P2P lending already hit the wall?

The two biggest U.S. P2P lenders, Prosper and Lending Club, started operations in 2005 and 2007, respectively. Over the past decade, their business has grown so that they now originate more than $10 billion in loans per year. The public information provided by Lending Club gives us an opportunity to judge how they are doing. At first, P2P lending returns appear remarkably high (adjusted for volatility), but growing evidence of adverse selection highlights how difficult it will be to sustain growth.

When we last wrote about P2P lending, we suggested that profitability might be a consequence of the booming economy (see here and here). We concluded that one would need to see performance in a recession before judging P2P’s long-run potential. That is, when you are making consumer loans, it is relatively easy to make money as the unemployment rate falls from 10% to 3.5%. However, profitability over the course of an entire business cycle, including periods when joblessness is rising, is an entirely different story.

Well, maybe there is no need to wait….

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Better capitalized banks lend more and lend better

Many people seem to think that when authorities increase capital requirements, banks lend less. The advocates of this view go on to argue that, since credit is essential for economic growth, we should not impose overly tough constraints on banks. Put another way, a number of people believe that we have gone too far in making the financial system safe and the cost is lower growth and employment.

Treasury Secretary-designate Steven Mnuchin appears to share the view that financial regulation has restrained the supply of credit: in a recent interview, he is quoted as saying “The number one problem with Dodd-Frank is that it’s way too complicated and cuts back lending.” One interpretation of this is that Secretary-designate Mnuchin will support proposals like House Financial Services Chair Jeb Hensarling’s Financial CHOICE Act to allow banks to opt for a simple capital standard as an alternative to strict regulatory scrutiny.

Our reaction to this is three-fold. First, for most banks, which are very small and pose little threat to the financial system, a shift toward simpler capital requirements—so long as they are high enough—may be both effective and efficient; for the largest, most systemic intermediaries, higher capital requirements should still be accompanied by strict oversight. Second, we see no evidence that higher bank capital is associated with lower lending. In fact, quite the opposite. Third, given that the 2007-09 financial crisis was the result of too much borrowing—and that over-borrowing is a leading indicator of financial crises—it follows that not all reductions in lending are bad. We take each of these points in turn...


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