Friendship effect in online P2P lending

With the enormous growth of the Internet, numerous opportunities have emerged for us to expand our knowledge, find new information, buy and sell our belongings or even expand our possibilities to find work online. Besides everything the internet has in the meantime became a powerful force in accelerating financial innovation of peer-to-peer lending market.

We’re well aware of how Kickstarter, Indiegogo, Angels, VCs, etc transformed businesses, created success stories, and reevaluated the roles of classical intermediaries. However, in the recent years online peer-to-peer lending has emerged as an appealing new channel which allows individual lenders to collect their funds to finance loan requests from individuals and businesses. To keep it short and simple it’s essentially a debt form of crowdfunding. Businesses, investors and regulators are all increasingly interested in this business model. It’s a mystery and a wonderful example of how new internet technologies can and already are transforming the finance industry.

But what are the main mechanisms of peer-to-peer market that make this possible? And how can you behave and perform as credible individual to strangers online?

The online world doesn’t know how well you dress every Sunday to family gatherings, it doesn’t care how thoughtful you are to your grandparents and most certainly it doesn’t show that you always pay your bills on time. However, any individual with an access to the internet has the ability to check who your friends are on social media. And while we can agree that the saying “Show me who your friends are and I’ll tell you who you are” is not that far from the truth, especially when the online world blossoms on the garden of your social intelligence that you have used to attract, entertain and seed your social circle.

FRIENDSHIP IN THE P2P LENDING MARKET:

Interestingly enough, numerous lending platforms prominently display information about friends of borrowers in the listing as the most important piece of information outside the credit information and listing information about the borrower. Which means that the biggest signal of credit quality of an individual are their online friendships or borrowers. The more friendships does an individual have, the more credible he looks in the eyes of a lender. Friendships tend to increase the probability of successful funding, lower interest rates on funded loans, and are associated with lower default rates. The main reason that friendships are so important to keep on a display is because people don’t believe impersonal sources and instead rely heavily on other people’s judgement and their reliability more than they would anyone else. Individuals believe that borrowers with friends vouching for them are less likely to default and are seen as more trustworthy and better people.

SOCIAL STIGMA:

Friendship ties work both ways as they are equally beneficial for the lender as well as for the borrower. Not only if an individual defaults, they will suffer consequences such as lower credit score, increased credit cost or contraction in credit supply, the individual suffers from social stigma effects which are relevant when friends get to know about their default and refuse to vouch or be associated with them. The social stigma matters, since borrowers who perceive themselves likely to default will tend to avoid forming friendships and causing tension between their friends. Which is why borrowers with friends are more likely to be credible source of credit quality and will less likely default. It’s an indication that friendships lower the possibility of a hazard along the way and positively affect the individual.

In many ways, friendships can shape your life, but as one can see that they can also have an incredible effect to economic outcomes. This idea that economic transactions are embedded in social relationships is however not new and vouching for your friend makes an enormous difference in the new peer-to-peer world as its rapidly changing our ways.

And in the end, no matter the story, the conclusion always stays the same.. Friendships matters! So call your friend today and tell them you have a vouch in store for them.

References:

De Liu, Daniel J. Brass, Yong Lu, Dongyu Chen: “FRIENDSHIPS IN ONLINE PEER-TO-PEER LENDING: PIPES, PRISMS, AND RELATIONAL HERDING”

Liran Einav, Chiara Farronato, Jonathan Levin: “Annual Review of Economics”, Vol. 8:615–635 (Volume publication date October 2016) https://doi-org.dcu.idm.oclc.org/10.1146/annurev-economics-080315-015334

Nagpurnanand R. Prabhala, Siva Viswanathan Robert H. Smith: “Judging Borrowers by the Company They Keep: Friendship Networks and Information Asymmetry in Online Peer-to-Peer Lending”

Xiangru Chen, Lina Zhou , Difang Wan: “Group social capital and lending outcomes in the financial credit market: An empirical study of online peer-to-peer lending”