In the following paper, I want to give an insight in two financial markets, the online peer to peer lending market and the payday loan market. Both are examples for disintermediated finance. Disintermediation means to withdraw funds from intermediary financial institutions, such as banks and savings/loan associations, in order to invest them directly. Simply put, in disintermediated finance one gets rid of the middleman or intermediary.
This paper is organized as follows. At first Chapter 2 will look into the online peer to peer market of Prosper.com. Therefore, I will analyse a paper of the authors Lin, Prabhala, and Viswanathan (2013) called "Judging borrowers by the company they keep: Friendship networks and information asymmetry in online peer-to-peer lending".
In Section 2.1 I will start with an introduction to the market and the author’s intention. Section 2.2 will explain the system of the online platform Prosper.com. The following section will outline the empirical results of the authors, in order to express the result’s implication in the last section of chapter 2. Chapter 3 will continue with payday loans. The first section 3.1 gives an introduction into payday loans and explains how the industry of payday loans works. The second section 3.2 will analyse one specific paper of Adrian Morse (2011) called "Payday lenders: Heroes or Villains?" The last section 3.3 will give a summary of the author’s findings and question them critically.
Table of Contents
1. Introduction
2. Online peer to peer lending
2.1 Introduction to the Market and the Author’s Intention
2.2 The System of Prosper
2.3 Data and empirical Results
2.4 Result’s Implications
3. Payday Loans
3.1 Definition of Payday Loans and how the Industry works
3.2 Payday lenders: Heroes or Villains?
3.3 Review of the Author’s Findings
Objectives and Research Focus
This paper examines the mechanisms and socio-economic impacts of two forms of disintermediated finance: the online peer-to-peer (P2P) lending market and the payday loan industry. The primary research focus lies on understanding how alternative lending structures attempt to bridge information asymmetries and how they affect both borrowers and broader social outcomes, such as crime rates or foreclosure frequency.
- Analysis of trust and friendship networks as signals of creditworthiness in P2P lending.
- Evaluation of the operational structure and risk assessment mechanisms of the Prosper.com platform.
- Investigation into whether payday loans mitigate or exacerbate financial distress for vulnerable populations.
- Critical discussion of regulatory frameworks and the potential for predatory practices within the non-traditional banking sector.
Excerpt from the Book
3.1 Definition of Payday Loans and how the Industry works
A payday loan is a short term loan made for seven to 30 days for a small amount. The majority of the payday loans (about eighty percent) are smaller than $300. If you accept such a loan you have to pay a fee, which ranges from $15 to $30 on each $100 advance. A typical example for such a loan would be a payday loan about $300. Here a borrower would write a post-dated check for $300 and receives $255 in cash. In this example the lender would keep 45$ ($15 for each $100). The lender keeps the check until the next payday before depositing it in his own account. The qualifications for a payday loan are rather simple. The typical requirements are a home address, a valid checking account, a driver’s license, a social security number, a verification of employment, and minimum earnings of $1000 a month.
A definition of how payday loans are provided is made by Robinson in 2001. “Payday loans are provided by stand-alone companies, by check cashing outlets and pawn shops, through faxed applications to servicers, online, and via toll-free telephone numbers”. This means there is no need for a depository institution to carry out payday loans.
Summary of Chapters
1. Introduction: This chapter outlines the concept of disintermediated finance and introduces the two core areas of study: P2P lending and payday loans.
2. Online peer to peer lending: This section analyzes the platform Prosper.com, focusing on how friendship networks act as a proxy for credit quality and mitigate adverse selection.
3. Payday Loans: This chapter defines the payday loan industry, its growth, and critically examines whether these loans serve as a vital financial safety net or predatory practice during individual financial crises.
Keywords
Disintermediated finance, Peer-to-peer lending, Payday loans, Prosper, Creditworthiness, Information asymmetry, Financial regulation, Foreclosures, Predatory lending, Risk assessment, Social networks, Adverse selection, Consumer finance, Banking functions.
Frequently Asked Questions
What is the core focus of this term paper?
The paper explores the mechanics and social implications of two non-traditional finance sectors: online peer-to-peer lending platforms and the payday loan industry.
What are the central thematic areas?
The study centers on the removal of financial intermediaries, the use of alternative data (like social network links) to assess credit risk, and the regulatory challenges associated with high-interest short-term loans.
What is the primary objective of the research?
The objective is to analyze whether these financial alternatives effectively bridge information gaps and provide social value, or if they facilitate predatory practices that harm vulnerable consumers.
Which research methods are employed?
The paper conducts a literature review and secondary analysis of empirical findings from academic studies (such as Lin et al. and Morse), evaluating regression results regarding default rates and the socio-economic impacts of lending.
What is covered in the main body of the text?
The body covers the operational model of Prosper.com, the statistical correlation between friendship and creditworthiness, and the impact of payday lending on local foreclosure and crime rates.
Which keywords best describe the document?
Key terms include disintermediated finance, P2P lending, payday loans, information asymmetry, and creditworthiness.
How does the Prosper platform mitigate the problem of adverse selection?
Prosper encourages users to form "friendship" networks, which serve as a mechanism to signal credit quality to other lenders, thereby reducing the risk of lending to unknown borrowers.
What does the empirical analysis suggest about payday loans after natural disasters?
The analysis indicates that while access to payday loans may help mitigate foreclosures in the short term, the industry remains controversial due to high interest rates and the potential for a cycle of debt.
Why are payday loans often described as predatory?
They are described as predatory because they often carry very high annual percentage rates, reaching up to 1000%, and frequently involve repeat borrowing, which keeps the borrower in a cycle of financial distress.
Is the regulation of the payday loan industry considered sufficient?
The author argues that regulation in the payday sector is currently insufficient and cautions against demands for deregulation, as the industry's business model relies on the financial vulnerability of its customers.
- Quote paper
- Christian Kreutzer (Author), 2016, Disintermediated finance peer-to-peer lending and payday loans, Munich, GRIN Verlag, https://www.grin.com/document/432918
