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Need A Loan?

Published: December 19, 2016

The modern peer-to-peer (P2P) online lending industry gets a top-to-bottom look from Laura Gonzalez, a new face in CSULB’s Department of Finance in the College of Business Administration.

Gonzalez’s research focuses on financial institutions, corporate finance and entrepreneurship which she has presented before the Federal Reserve Board in Washington D.C., the Federal Reserve Bank of New York, the Federal Reserve Bank of Chicago and the Federal Deposit Insurance Corporation. Her 2015 study titled “Competition against Common Sense: Insights on Peer-to-Peer Lending as a Tool to Allay Financial Exclusion” was published in the International Journal of Bank Marketing’s special issue on financial exclusion.

The peer-to-peer online lending industry is here to stay, according to Gonzalez.

“What about people who lost their jobs in the 2008 aftermath but still needed to repair the roof of their home? Roof repairs and other common needs cannot wait, and even in the absence of a crisis, it is easier and faster in many cases to fund loans online at a competitive rate,” said Gonzalez. “There is a need and an opportunity for people to borrow and to lend money online to strangers. This is a new model of financial intermediation.”

Gonzalez pointed to the industry’s roots in 2005’s United Kingdom.

“Within a year, the business model arrived in the U.S. where it has experienced exponential growth,” she said. “Billions of dollars have been lent and repaid. In the U.S., we have the largest market in the world, but there are peer-to-peer lending sites all over the world. I’ve looked at sites in China, Brazil, South Korea, India, Germany, Finland, Italy and France besides the United Kingdom and United States.”

The modern peer-to-peer lending industry started in the U.S. in February 2006 with the launch of Prosper, followed by Lending Club. By June 2012, Lending Club was the largest peer-to-peer lender in the U.S. based on issued loan volume and revenue, followed by Prosper. Lending Club is also the world’s largest peer-to-peer lending platform. The two largest companies have collectively serviced more than 180,000 loans with $2 billion in total.

In 2008, the Securities and Exchange Commission (SEC) required that peer-to-peer companies register their offerings as securities, pursuant to the Securities Act of 1933. Prosper and Lending Club had to temporarily suspend offering new loans, while others, such as the UK-based Zopa Ltd., exited the U.S. market entirely. Both Lending Club and Prosper gained approval from the SEC to offer investors notes backed by payments received on the loans.

“More people turned to peer-to-peer companies for lending and borrowing following the financial crisis of late 2000s because borrowing from banks was time-consuming and difficult,” Gonzalez said. “On the other hand, the peer-to-peer market also faced increased scrutiny because some investors were obtaining substantial returns in their investment portfolios while other investors were facing substantial losses.”

When Gonzalez began her social online lending research, she suspected online lenders were often unsophisticated, and when sophisticated, subject to unconscious biases.

Borrowers often accompany their loan applications with photos, according to Gonzalez. She created a mock online lending site with mock applications that were almost identical with the exception of photos. The photos were either attractive headshots she found online or digitally-altered significantly less attractive modifications. She then asked college students as well as the general public to make lending decisions, as they would on a P2P lending online site. Interestingly, and although the loan applications were the same, the lenders would make different lending decisions based on what was different, the photos, the looks of the mock loan applicants. She specifically examined the success of male applicants and female applicants of different ages with lenders of different genders and ages and surveyed the lending decision as well as the lenders’ experience in investments. She also examined patterns and tested for biases.

“Overall, I found that lenders inferred different degrees of credibility, trustworthiness and competence based on photos, inferences that had a significant impact in their lending decisions. Beauty can be beastly, it doesn’t always help,” she noted. “The traditional finding in finance is that beauty helps. For example, good-looking CEOs get paid more, and when their hiring is announced, stock prices go up. But the key about beauty effects is in the context, as other disciplines have noticed. In peer-to-peer lending, photos of attractive men did not always help their loan funding. Women lenders don’t seem to care much whether they loan to a woman or a man, and male lenders didn’t penalize attractive women, but attractive male borrowers were penalized by male lenders. Even when I manipulated the loan application to give the attractive male borrowers an exceptional credit rating in their loan applications, to make them stellar, they were still penalized by the male lenders.” A related experimental study was published in the Journal of Experimental and Behavioral Finance.

Gonzalez earned her Ph.D. in finance at University of Florida in 2008. Previously, she simultaneously earned an MBA in finance and an M.A. in foreign languages and literatures—English, French and Spanish—at Southern Illinois University. She earned a B.S. in electrical engineering at the same time as B.A.s in piano music performance and education while still in Spain.

Gonzalez has noted a rising involvement in online peer-to-peer lending by financial institutions, but the lending by private citizens continues growing as well.

“There are online lenders who have no experience as loan officers and have not studied business. Even among business students I found significant unfounded unconscious conclusions that would harm lending decisions and investment portfolio returns,” she said. “Lenders tend to diversify. Instead of granting $1,000 to one loan application, they grant $100 here and $100 there. In usual portfolios of several thousand dollars, some lenders earn as much as 20 percent but others lose 20 percent. It is in everyone’s best interest that lenders be trained so that the sites are profitable, trustworthy borrowers can raise capital on time and lenders can make reasonable profits.”