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Borrowing on Online Lending Platforms May Increase Consumer Bankruptcies

Online lending platforms are gaining popularity as consumers realize the ease with which they can obtain low-interest loans, particularly consumers with less than stellar credit scores. Online lending platforms are a recent disruptor to the fintech space, offering a financial resource for those who may need a loan to pay down credit card debt or survive financial hardship. Recently, Sudheer Chava and Eric Overby, two Georgia Tech Scheller College of Business faculty with expertise in the fintech industry, published separate papers that examined the effects of online lending platforms.

In the paper “Impact of Marketplace Lending on Consumers' Future Borrowing Capacities and Borrowing Outcomes” by Chava; Rohan Gandury, Georgia Tech PhD alumnus and assistant professor of finance at Emory University; Nikhil Paradkar, Georgia Tech PhD alumnus and assistant professor of finance at the University of Georgia; and Yafei Zhang, Georgia Tech PhD candidate, the researchers asked two questions. How does borrowing from online lending platforms impact borrowers’ credit scores and default rates? Does borrowing an identical credit product (i.e., an unsecured personal installment loan) from a traditional bank also result in the same impact on borrowers’ credit scores and default rates?

Chava and colleagues identified more than 1.2 million borrowers on a major online lending platform and matched them to similar borrowers that have applied for an unsecured installment loan from a bank. That is, they identified pairs of borrowers with identical credit and income profiles (i.e., the same credit scores, monthly incomes, total debt, etc.), with the only observable difference between these two borrowers being that one borrower’s loan originated from an online lending platform, while the other borrower’s loan originated from a traditional bank. The study gathered data from both borrowers 12 months before the origination of the loan to 24 months after the origination of the loan. The team discovered that consumers who borrow from an online lender tend to have lower credit scores and higher default rates two years after the online loan origination compared to pre-origination levels. These same online borrowers also have lower long-run credit scores and higher long-run default rates in general compared to bank borrowers.

 “What we find suggests that online lending can potentially benefit borrowers that use the debt to refinance their credit card debt at a lower rate. But borrowers that don’t repay their credit card debt or take on additional debt may end up with higher defaults and worse financial outcomes,” said Chava. “More broadly, the focus of many FinTech players, including online lending platforms, is on reducing frictions and making it much easier to borrow than banks. However, it is important to make sure that consumers can process the complex financial information quickly and for consumers to use debt responsibly.”

In parallel with Chava’s paper, Overby and Hongchang Wang, University of Texas at Dallas, asked a similar question in their “How Does Online Lending Influence Bankruptcy Filings?” paper. The two papers overlap in the topics researched, and their findings complement each other.

Wang and Overby compared changes in bankruptcy filings in counties in which two online lending platforms were available to those in counties in which they were. They found that the introduction of online lending platforms is associated with an increase in bankruptcy filings. This may be because the ease of receiving an online loan causes borrowers to overextend themselves financially, leading them to bankruptcy.

 “The two studies from Scheller are related in an interesting way. One of the main reasons that borrowers get online loans is to consolidate credit card debt, given that the interest rates for online loans are often lower than those for credit cards. This should improve borrowers’ financial health and help them avoid bankruptcy,” said Overby.

 But Wang and Overby’s research found that this may not be the case. Chava’s study provides a potential explanation. It may be that many borrowers use online loans to consolidate credit card debt, as intended. This increases borrowers’ credit scores, which may mean that they receive and often accept additional credit offers. This may lead to more credit card debt and subsequent default – and potentially, bankruptcy.

 “We’re not saying that online lending platforms are bad. They have many virtues. However, it is important to show that these platforms can get borrowers into financial trouble. We are heartened by recent initiatives, such as Lending Club’s ’balance transfer loans’ that send loan funds directly to the borrowers’ creditors. These can keep borrowers from becoming overextended and help address the issue that we document in our paper,” said Wang.

Chava’s “Impact of Marketplace Lending on Consumers' Future Borrowing Capacities and Borrowing Outcomes” will be published in the Journal of Financial Economics and Overby’s “How Does Online Lending Influence Bankruptcy Filings?” will be published in Management Science.

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