-
IntroductionAdvantages
Adverse Selection, Trust and ReputationThe Model
Welfare AnalysisConclusions
P2P Lending and Screening Incentives
Dairo Estrada & Paula ZamoraThe Second International
Workshop P2P Financial Systems 2016
September 6, 2016
P2P Lending and Screening Incentives
-
IntroductionAdvantages
Adverse Selection, Trust and ReputationThe Model
Welfare AnalysisConclusions
Overview
1 Introduction
2 Advantages
3 Adverse Selection, Trust and Reputation
4 The ModelPerfect ScreeningImperfect ScreeningFinancial
Inclusion and Welfare
5 Welfare Analysis
6 Conclusions
P2P Lending and Screening Incentives
-
IntroductionAdvantages
Adverse Selection, Trust and ReputationThe Model
Welfare AnalysisConclusions
Composition of Crowdfunding by category
Source: Company Data, Morgan Stanley Research estimates
P2P Lending and Screening Incentives
-
IntroductionAdvantages
Adverse Selection, Trust and ReputationThe Model
Welfare AnalysisConclusions
Peer to peer Lending Process
Source: Aveni(2015)
P2P Lending and Screening Incentives
-
IntroductionAdvantages
Adverse Selection, Trust and ReputationThe Model
Welfare AnalysisConclusions
Loan Distribution Originated by P2P platform
Source: Company Data, Morgan Stanley Research estimates
P2P Lending and Screening Incentives
-
IntroductionAdvantages
Adverse Selection, Trust and ReputationThe Model
Welfare AnalysisConclusions
Advantages of P2P Platforms
Have broader access to information (Big Data)
Lower costs compared to the intermediation operations of
banks
Improve financial inclusion
Quick adjustment to new market conditions (technology, new
instruments)
P2P Lending and Screening Incentives
-
IntroductionAdvantages
Adverse Selection, Trust and ReputationThe Model
Welfare AnalysisConclusions
Costs and Interest Spreads for Banks and Lending Club
Costs in Basis Points
Sources: Aveni (2015) and Lendit 2013
P2P Lending and Screening Incentives
-
IntroductionAdvantages
Adverse Selection, Trust and ReputationThe Model
Welfare AnalysisConclusions
Information Role
The agility of the system, customer satisfaction, the success of
the platform andits growth depend directly on the number of agents
willing to participate in themarket on both sides.
The challenges:1 Build a solid performance history to generate
credibility.2 Maintain users’ confidence in the system.
Importance of the screening process: platforms are highly
interested in enforcingstrict lender and borrower requirements to
guarantee quality in the transactions,increase reputation and guard
against misbehavior and fraud.
P2P Lending and Screening Incentives
-
IntroductionAdvantages
Adverse Selection, Trust and ReputationThe Model
Welfare AnalysisConclusions
Perfect ScreeningImperfect ScreeningFinancial Inclusion and
Welfare
The Model
A model with screening activities
Agents receive a pool of loan applications and decide the amount
of them to bescreened (k) in order to grant loans.
The agents cannot identify directly the type of project without
screening, butthey know the share of good (low-risk) projects in
the economy, [λ ∈ (0, 1)].The bank’s optimal number of loans
granted is small relative to market demand.
Two questions:1 How do the economic outlook, the screening costs
and the quality of screening affect
the incentives of the bank and the platform to screen potential
borrowers?2 What is the resulting impact on loan supply in the
market?
P2P Lending and Screening Incentives
-
IntroductionAdvantages
Adverse Selection, Trust and ReputationThe Model
Welfare AnalysisConclusions
Perfect ScreeningImperfect ScreeningFinancial Inclusion and
Welfare
Monopoly Case
Timing of the Bank’s problem with Perfect Screening
P2P Lending and Screening Incentives
-
IntroductionAdvantages
Adverse Selection, Trust and ReputationThe Model
Welfare AnalysisConclusions
Perfect ScreeningImperfect ScreeningFinancial Inclusion and
Welfare
Monopoly Case
The profit function:
ΠpsBank (k) = kλπL − rL− k2z (1)
L = kλ is the amount of loans that the bank grants
The optimal amount of loans granted by the bank is:
LpsM =λ2πL − rλ2
2z(2)
P2P Lending and Screening Incentives
-
IntroductionAdvantages
Adverse Selection, Trust and ReputationThe Model
Welfare AnalysisConclusions
Perfect ScreeningImperfect ScreeningFinancial Inclusion and
Welfare
Monopoly Case
Amount of loan applications screened by the bank
P2P Lending and Screening Incentives
-
IntroductionAdvantages
Adverse Selection, Trust and ReputationThe Model
Welfare AnalysisConclusions
Perfect ScreeningImperfect ScreeningFinancial Inclusion and
Welfare
Duopoly Case
A bank and a platform are active in the credit market and they
randomly andindependently choose which loan applications to assess.
Hence, we can find fourgroups of loan applications:
P2P Lending and Screening Incentives
-
IntroductionAdvantages
Adverse Selection, Trust and ReputationThe Model
Welfare AnalysisConclusions
Perfect ScreeningImperfect ScreeningFinancial Inclusion and
Welfare
Sequence of decisions in a Duopoly lending industry with Perfect
Screening
P2P Lending and Screening Incentives
-
IntroductionAdvantages
Adverse Selection, Trust and ReputationThe Model
Welfare AnalysisConclusions
Perfect ScreeningImperfect ScreeningFinancial Inclusion and
Welfare
Duopoly Case
The profit function for agent i is:
Πpsi (ki , kj ) = kikjλ
2πL + ki (1− kj )λπL − rLi − k2i zi (3)
zA > zB
The number of loan applications that agent i decides to finance
is:
Lpsi = kikjλ
2+ ki (1− kj )λ (4)
P2P Lending and Screening Incentives
-
IntroductionAdvantages
Adverse Selection, Trust and ReputationThe Model
Welfare AnalysisConclusions
Perfect ScreeningImperfect ScreeningFinancial Inclusion and
Welfare
Duopoly Case
The optimal values of kA and kB expressed through the exogenous
parameters are:
kpsA =λ2
2(r − πL)2 + 2λ(r − πL)zBλ2
4(r − πL)2 − 4zAzB
(5)
kpsB =λ2
2(r − πL)2 + 2λ(r − πL)zAλ2
4(r − πL)2 − 4zAzB
(6)
P2P Lending and Screening Incentives
-
IntroductionAdvantages
Adverse Selection, Trust and ReputationThe Model
Welfare AnalysisConclusions
Perfect ScreeningImperfect ScreeningFinancial Inclusion and
Welfare
Duopoly Case
Screening and Economic Outlook
0 0.1 0.2 0.3 0.4 0.5 0.6 0.7
Economic Outlook ( λ )
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1S
cree
nin
g (
K)
ZBank
=0.09, ZPlatform
=0.03, r=0.03, πL=0.2
KMonopoly
ps
KBank
ps
KPlatform
ps
P2P Lending and Screening Incentives
-
IntroductionAdvantages
Adverse Selection, Trust and ReputationThe Model
Welfare AnalysisConclusions
Perfect ScreeningImperfect ScreeningFinancial Inclusion and
Welfare
Monopoly Case
Screening is costly (z > 0) and imperfect, β ∈ [0, 1]. The
risk that the bank orthe platform approves unqualified loan
applications rises as β increases.
Mistakenly approved bad projects have an strictly negative
expected revenue forthe agent.
P2P Lending and Screening Incentives
-
IntroductionAdvantages
Adverse Selection, Trust and ReputationThe Model
Welfare AnalysisConclusions
Perfect ScreeningImperfect ScreeningFinancial Inclusion and
Welfare
The profit function for the bank is then as follows:
ΠisBank (k) = k[λπL + (1− λ)βπH ]− rL− k2z (7)
The number of loans funded also changes, given the
misclassification of projects:
L = k[λ+ (1− λ)β] (8)
The optimal number of loan applications that the bank should
screen to maximizeprofits is:
k isM =λπL + (1− λ)βπH − r [λ+ (1− λ)β]
2z(9)
P2P Lending and Screening Incentives
-
IntroductionAdvantages
Adverse Selection, Trust and ReputationThe Model
Welfare AnalysisConclusions
Perfect ScreeningImperfect ScreeningFinancial Inclusion and
Welfare
Duopoly Case
Both the screening costs, z, and the probability β differ among
the bank and theplatform.
The groups also include high-risk projects, given the
probability ofmisclassification.
We asume that the platform has a better technology to screen (βB
< βA) and itis also more efficient in the screening process (zB
< zA).
P2P Lending and Screening Incentives
-
IntroductionAdvantages
Adverse Selection, Trust and ReputationThe Model
Welfare AnalysisConclusions
Perfect ScreeningImperfect ScreeningFinancial Inclusion and
Welfare
According to these new conditions, the profit functions will be
for the bank and theplatform, respectively:
ΠisA (kA, kB ) =kA [λπ
L + (1 − λ)βAπH ]kB [λπ
L + (1 − λ)βBπH ]
2(10)
+kA(1 − kB )[λπL + (1 − λ)βAπ
H ] − rLA − k2AzA
ΠisB (kA, kB ) =kA [λπ
L + (1 − λ)βAπH ]kB [λπ
L + (1 − λ)βBπH ]
2(11)
+kB (1 − kA)[λπL + (1 − λ)βBπ
H ] − rLB − k2B zB
P2P Lending and Screening Incentives
-
IntroductionAdvantages
Adverse Selection, Trust and ReputationThe Model
Welfare AnalysisConclusions
Perfect ScreeningImperfect ScreeningFinancial Inclusion and
Welfare
Screening and Expected Losses
-0.2 -0.18 -0.16 -0.14 -0.12 -0.1 -0.08 -0.06
Expected losses from high-risk projects ( πH)
0
0.1
0.2
0.3
0.4
0.5
0.6
Scr
een
ing
(K
)β
Bank=0.24, β
Platform=0.2, Z
Bank=0.09, Z
Platform=0.04, r=0.03, λ=0.3, πL=0.2
Kps
Platform
Kis
Platform
Kps
Monopoly
Kps
Bank
Kis
Monopoly
Kis
Bank
P2P Lending and Screening Incentives
-
IntroductionAdvantages
Adverse Selection, Trust and ReputationThe Model
Welfare AnalysisConclusions
Perfect ScreeningImperfect ScreeningFinancial Inclusion and
Welfare
Screening and Economic Outlook
0.3 0.4 0.5 0.6 0.7 0.8 0.9 1
Economic Outlook ( λ )
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7S
cree
nin
g (
K)
βBank
=0.24, βPlatform
=0.2, ZBank
=0.15, ZPlatform
=0.1, r=0.03, πL=0.2, πH=-0.3
Kps
Platform
Kis
Platform
Kps
Bank
Kis
Bank
P2P Lending and Screening Incentives
-
IntroductionAdvantages
Adverse Selection, Trust and ReputationThe Model
Welfare AnalysisConclusions
Perfect ScreeningImperfect ScreeningFinancial Inclusion and
Welfare
Screening and Economic Outlook
0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1
Economic Outlook ( λ )
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7S
cree
nin
g (
K)
βBank
=0.24, βPlatform
=0.2, Z=0.1, r=0.03, πL=0.2, πH=-0.3
Kps
Kis
Platform
Kis
Bank
P2P Lending and Screening Incentives
-
IntroductionAdvantages
Adverse Selection, Trust and ReputationThe Model
Welfare AnalysisConclusions
Perfect ScreeningImperfect ScreeningFinancial Inclusion and
Welfare
Perfect Screening
Loans and Economic Outlook
0 0.1 0.2 0.3 0.4 0.5 0.6 0.7
Economic Outlook ( λ )
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1L
oan
s (L
)Z
Bank=0.09, Z
Platform=0.03, r=0.03, πL=0.2
LpsMonopoly
LpsBank
LpsPlatform
LpsDuopoly
P2P Lending and Screening Incentives
-
IntroductionAdvantages
Adverse Selection, Trust and ReputationThe Model
Welfare AnalysisConclusions
Perfect ScreeningImperfect ScreeningFinancial Inclusion and
Welfare
Imperfect Screening
Loans and Economic Outlook
0.3 0.4 0.5 0.6 0.7 0.8 0.9 1
Economic Outlook ( λ )
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8L
oan
s (L
)β
Bank=0.24, β
Platform=0.2, Z
Bank=0.15, Z
Platform=0.1, r=0.03, πL=0.2, πH=-0.3
Lps
Duopoly
Lis
Duopoly
Lps
Monopoly
Lis
Monopoly
P2P Lending and Screening Incentives
-
IntroductionAdvantages
Adverse Selection, Trust and ReputationThe Model
Welfare AnalysisConclusions
Perfect ScreeningImperfect ScreeningFinancial Inclusion and
Welfare
Imperfect Screening
Loans and Economic Outlook
0.3 0.4 0.5 0.6 0.7 0.8 0.9 1
Economic Outlook ( λ )
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8L
oan
s (L
)β
Bank=0.24, β
Platform=0.2, Z
Bank=0.15, Z
Platform=0.1, r=0.03, πL=0.2, πH=-0.3
Lps
Duopoly
Lis
Duopoly
Lps
Monopoly
Lis
Monopoly
P2P Lending and Screening Incentives
-
IntroductionAdvantages
Adverse Selection, Trust and ReputationThe Model
Welfare AnalysisConclusions
Welfare Analysis
The socially optimal fraction of loan applications that should
be screened isgreater than the fraction of loan applications that
the bank screens.
kps∗M =λπL
2z> kpsM =
λπL − rλ2z
(12)
P2P lending increases loan supply and seems to be a good
alternative for thosewho deserve credit, but do not have access to
financial services provided byregulated financial institutions.
This would be an important innovation indeveloping economies, where
many people depend on informal mechanisms thathave forced them to
pay high interest rates and pawn or sell assets.
These results are valid when we evaluate the model under perfect
and imperfectscreening condition.
P2P Lending and Screening Incentives
-
IntroductionAdvantages
Adverse Selection, Trust and ReputationThe Model
Welfare AnalysisConclusions
Risks and Regulation
The role of regulation
Riskier borrowers: regulators should require platforms to have
accurate screeningstandards.
Data and confidentiality
Algorithms and discrimination
Platform’s incentives to reveal information
Monetary Policy
P2P Lending and Screening Incentives
-
IntroductionAdvantages
Adverse Selection, Trust and ReputationThe Model
Welfare AnalysisConclusions
Conclusions
Final Comments
Lower screening costs, a better economic outlook and higher
profits from goodprojects promotes the platform and the bank to
screen more.
As long as the platform has lower screening costs and better
screening quality,then it will grant more loans than the bank.
A lower quality in screening reduces the incentives of screening
of both agentsand therefore they provide less credit to the
market.
The gap between the optimal amounts of screening under imperfect
and perfectscreening conditions reduces as the economic outlook
improves.
P2P Lending and Screening Incentives
IntroductionAdvantagesAdverse Selection, Trust and ReputationThe
ModelPerfect ScreeningImperfect ScreeningFinancial Inclusion and
Welfare
Welfare AnalysisConclusions