The marketplace lending industry, which is less peer-to-peer these days and relies more on packaging and selling bonds to fund its business, seems to be taking a page from recent troubled banking history. It appears to be ratings shopping, which was widely credited for exacerbating the housing credit boom that ended in financial crisis. In fact, ratings shopping may now be masking higher default rates and the true health of peer-to-peer lending from investors. In short, the sector may be more volatile than many think, with protections written into deals to insulate investors from losses.
The problem is that upstart online and peer-to-peer lenders face the problem of a limited pool of high-quality borrowers. Thus, they often lower their standards and fund riskier customers. Just as in traditional banking, however, problems often arise out of this. On the one hand, it can mean hiding fees from borrowers; on the other hand, it can mean masking potential losses from investors. The friendly peer-based lending environment promised just a few years ago, one where everyone wins, is turning out to be more like the traditional finance business, where there are unsuspecting losers.