To Lend or Not to Lend: Exploring the Early Days of Peer-to-Peer Lending to Small Businesses

Introduction

As distrust and dissatisfaction with commercial banks grew during the recent financial crisis, there was large growth in nonstandard types of borrowing arrangements. One such arrangement that has seen substantial growth in the past five years is crowdfunding —peer-to-peer (P2P) lending, in particular. Crowdfunding arrangements involve groups of individuals, not institutions, providing funding. As the name suggests, P2P loans are generally personal loans. However, small business owners often intermingle their personal and business finances so as overall P2P lending grew, so too did P2P borrowing for small business purposes.

The current paper looks at the individual loan-level data from Lending Club, focusing on those loans that were used by small business owners for their businesses. While there are other players in the market, Lending Club is the largest player in the US peer-to-peer lending space. In addition Lending Club provides a uniquely detailed data set that allows us to look at both the applicants and loans in more detail than is possible for other peer-to-peer sites. We begin by looking at the characteristics of loan applications that did and did not get funded. While loan purpose is not one of the criteria taken into account when evaluating loan applications, we find that loans intended for small business purposes were more likely to be funded than loans for other purposes. We then look at the interest rate paid on those loans that did get funded. Again, while loan purpose is not taken into account in assessing the credit quality of the application, loans for business purposes paid nearly one percentage point higher interest rate than other loans, holding borrower characteristics constant. Finally, we look at the loan performance. Our results indicate that loans for small business purposes were more than two-and-a-half times more likely to perform poorly.

The rest of the paper is organized as follows. We begin with a short discussion of crowdfunding and how P2P lending fits into the general crowdfunding framework. Then we look at the small business credit market and examine where small businesses have traditionally gotten their credit and how that may have been more difficult over the recent period. We next take a closer look at the data from Lending Club. The final three sections present our econometric results and the last section concludes.