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Tetyana Balyuk Sergei DavydenkoEmory University University of Toronto
FDIC-JFSR Bank Research ConferenceSeptember 6-7, 2018
Balyuk & Davydenko (2018) Reintermediation in FinTech
Often thought of as consumer loan "crowdfunding” "Disruptive outsiders", "an industry that was meant to be the
antithesis of Wall Street" ...
Designed to bring together borrowers and lenders without intermediaries
1September 6-7, 2018
Research question: Is FinTech likely to disintermediate markets?
Study evolution of online peer-to-peer (P2P) loan market
Balyuk & Davydenko (2018) Reintermediation in FinTech 2September 6-7, 2018
Two-sided market design (e.g., Uber, Airbnb, eBay)
Platform
• Loan pricing & screening• Fees tied to origination volume
?Investors
• Screening• Funding
Borrowers
• On-line loan request• ‘Hard’ borrower data
Important: information asymmetry and adverse selection P2P platform can be a trading venue or an intermediary
Balyuk & Davydenko (2018) Reintermediation in FinTech 3September 6-7, 2018
Disintermediation of P2P lending “Wisdom of crowds” makes investors better at
screening than the platform Investors switch from passive to active strategies as
learning improves returns to screening
Reintermediation of P2P lending Platform increases loan evaluation quality when it can
screen (Vallee & Zeng, 2018) Investors respond by becoming passive Average loan returns decrease
Balyuk & Davydenko (2018) Reintermediation in FinTech
Main stylized facts: P2P platform is a new intermediary1. P2P loan investors are sophisticated, passive, and algorithmic
- Share of passive investment strategies has increased over time2. Investors rely on platform’s pricing and fraud detection algorithms3. Screening by lending platform replaced investor screening over time
P2P platform processes hard information efficiently Platform produces useful info overcoming borrower adverse selection Platform’s default prediction has been improving over time Platform effectively screens out risky loan applications Investors earn respectable net returns, which decrease with reintermediation
Market structure vulnerable to moral hazard Platform’s moral hazard mitigated by threat of investor withdrawal
Reintermediation: Platform's growing technological expertisecrowds out loan screening by investors
4September 6-7, 2018
Balyuk & Davydenko (2018) Reintermediation in FinTech September 6-7, 2018
Main Stylized Facts
Balyuk & Davydenko (2018) Reintermediation in FinTech
- 91% of P2P loans provided by institutional investors- 82% of institutional loans automatically funded in full
5September 6-7, 2018
P2P investor pools
Balyuk & Davydenko (2018) Reintermediation in FinTech
- Investors in Active Institutional pool can screen loans
- But: Loans get funded within seconds of being listed Suggests automated investment by robots Funding time has been steadily decreasing → Faster algorithmic investment
6September 6-7, 2018
0
5
10
15
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Seco
nds
Funding time for Active Institutional pool
Median time to fund
“Active” institutional pool
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0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
70.0%
80.0%
90.0%
100.0%
Rating AA Rating A Rating B Rating C Rating D Rating E Rating HR
Institutional Original Retail Recycled Retail
Balyuk & Davydenko (2018) Reintermediation in FinTech 8September 6-7, 2018
Lending platform verifies loan applications it deems suspicious Risky/potentially fraudulent loans canceled after receiving funding (or not)
Investors don’t try to avoid these loans Canceled loans no less likely to receive funding
26%
23%
27% 27% 27% 27%25%
22%
17%
23%25%
26%
23%
15%16%
5%
0%
10%
20%
30%
All AA A B C D E HR
Proportion of canceled loans
Funded Unfunded
Balyuk & Davydenko (2018) Reintermediation in FinTech 9September 6-7, 2018
Balyuk & Davydenko (2018) Reintermediation in FinTech September 6-7, 2018
Platform’s Pricing & Screening
Balyuk & Davydenko (2018) Reintermediation in FinTech 10September 6-7, 2018
0.00%
1.00%
2.00%
3.00%
4.00%
5.00%
6.00%
7.00%
8.00%
781+ 741--780 701--740 681--700 661--680
Defaults by FICO: P2P vs traditional (2014-1015)
Revolvers* Lending Club Prosper*Source: Jagtiani and Lemieux (2017)
Balyuk & Davydenko (2018) Reintermediation in FinTech
- Prosper rating much more informative than FICO It incorporates FICO, but also Prosper’s analysis of historical
P2P loan defaults
11September 6-7, 2018
← Safe Prosper Rating Risky →F
I C O
AA A B C D E HR
780+ 0.95% 2.52% 4.30% 8.13% 15.02% 9.26%
760-779 1.49% 2.65% 4.38% 6.84% 10.14% 13.68%
700-739 2.02% 3.48% 5.19% 7.80% 10.22% 11.75% 12.94%
680-699 2.19% 3.93% 5.86% 8.54% 10.85% 12.38% 13.12%
660-679 2.68% 3.53% 5.42% 7.99% 10.49% 12.58% 13.89%
<660 3.27% 4.51% 7.08% 9.59% 11.22% 14.22%
Balyuk & Davydenko (2018) Reintermediation in FinTech
- ROC = measure of cross-sectional accuracy in credit risk assessment- Platform able to discern between borrowers of different credit quality- Sorting quality has increased over time after April 2013
12September 6-7, 2018
Balyuk & Davydenko (2018) Reintermediation in FinTech
- Borrowers screened out by the platform appear riskier Canceled and resubmitted loans have higher default rates
13September 6-7, 2018
Default hazard(1) (2) (3) (4)
Resubmitted 0.31*** 0.27*** 0.20*** 0.16***(24.9) (21.3) (15.9) (13.0)
Controls NO YES NO YESOld ELR FEs YES YES NO NONew ELR FEs NO NO YES YES
Month FEs NO NO NO NONo.obs. 376,489 299,435 376,489 299,435Log-likelihood -149487 -142216 -149485 -142249
Balyuk & Davydenko (2018) Reintermediation in FinTech
- Fewer loan cancellations when platform’s pricing improves
14September 6-7, 2018
Canceled(1) (2) (3) (4) (5) (6)
ROC area -0.84*** -0.84*** -0.84*** -0.84*** -0.84*** -0.84***(-37.9) (-38.0) (-38.1) (-37.7) (-38.0) (-38.0)
Passive -0.0020* 0.00037 0.00033(-1.81) (0.34) (0.30)
Funded -0.072*** -0.015 -0.072*** -0.015(-16.1) (-0.97) (-16.0) (-0.98)
FICO bins YES YES YES YES YES YESFICO bins * Funded NO NO YES NO NO YESNo.obs. 856,578 856,578 856,578 856,578 856,578 856,578R2 0.003 0.003 0.003 0.003 0.003 0.003
Balyuk & Davydenko (2018) Reintermediation in FinTech September 6-7, 2018
Loan Performance
Balyuk & Davydenko (2018) Reintermediation in FinTech 15September 6-7, 2018
- Net returns above returns on high yield bond benchmark- Loan returns decrease with reintermediation
Balyuk & Davydenko (2018) Reintermediation in FinTech 16September 6-7, 2018
- Loans originated in Passive Institutional pool default more often- But: Loan returns do not differ across passive vs. active strategies
Realized return Default hazard(1) (2) (3) (4) (5) (6) (7)
Passive -0.0091*** -0.00084 -0.0012 -0.0011 0.083*** 0.071*** 0.072***(-2.92) (-0.96) (-1.37) (-1.31) (4.01) (3.43) (3.49)
Rating FEs NO NO YES NO NO YES NOELR FEs NO NO NO YES NO NO YESMonth FEs NO YES YES YES NO NO NONo.obs. 268,995 268,994 268,994 268,994 342,927 342,927 342,927R2/LL 0.00046 0.013 0.014 0.014 -140037 -134687 -134374
Balyuk & Davydenko (2018) Reintermediation in FinTech September 6-7, 2018
Platform’s Moral Hazard
Balyuk & Davydenko (2018) Reintermediation in FinTech 17September 6-7, 2018
- Market structure vulnerable to platform’s moral hazard
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Predicted and realized returns by month of origination
Loans originated ($M) Estimated return Realized return
Moo
dy's
issu
es w
arni
ng
Moo
dy's
can
cels
war
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Balyuk & Davydenko (2018) Reintermediation in FinTech 18September 6-7, 2018
- P2P lending is dominated by institutional investors NOT peer to peer anymore! Almost all automated
- Sophisticated investors are increasingly becoming passive Passive loan-selection strategy is dominant and its share has grown over time Investors rely on platform's pricing and screening algos in funding decisions
- P2P platform’s volume maximization incentivizes quality pricing and screening Produces valuable incremental info overcoming borrower adverse selection Default prediction ability has been improving over time
- But the market structure is vulnerable to moral hazard Platform’s moral hazard mitigated by threat of investor withdrawal
Bottom line: Findings consistent with reintermediation: lending platform’s credit expertise crowds out investor screening in FinTech lending
Balyuk & Davydenko (2018) Reintermediation in FinTech 19September 6-7, 2018
Tetyana Balyuk Sergei DavydenkoEmory University University of Toronto