My Master Thesis Turned me into P2P Investor

Last year I graduated with a Master degree in Quantitative Finance from the University of Amsterdam. As my master thesis topic, I chose to explore the concept of peer-to-peer lending. This topic is relatively innovative for both academia and real-life application, so I would like to give it some more attention. Here, I would like to review my thesis to summarize key points. At the end of the article, I would like to share my experience as a P2P investor.

This article is structured as follows:

1. What is P2P lending?
2. What do we already know about it?
3. What did I investigate and how?
4. Discussion of the results
5. Last remarks about the P2P lending market
6. My experience with investing in this market

What is P2P lending? Peer-to-peer lending is a form of unsecured financial service which matches investors (lenders) and borrowers. It is an alternative approach to bank lending, which eases the entry barriers for borrowers and offers higher returns for lenders. The marketplace is structured in a form of a digital platform, where both parties can submit their applications.

In practice, investors are required to go through identity verification and complete a short assessment to verify their knowledge regarding the operations of the marketplace. This step ensures that the lenders are aware of the risks associated with P2P lending. The borrowers go through a risk assessment by giving some personal details such as income level, wealth level, family status, etc.

This lending alternative gained its popularity after the financial crisis in 2008 when the new Basel III regulations imposed stricter requirements on retail banks. As the result, many “low-quality borrowers” were restricted from obtaining a loan.

What do we already know about it? The P2P lending market appeared in 2005 with the first platform Zopa (UK) and emerged around 2008-2009. The trend is more popular in the US, where big platforms such as LendingClub and Prosper operate locally. Recently, cross border P2P lending platforms emerged in Europe. For instance, Mintos (a Latvian-based P2P platform) matches investors and borrowers worldwide and thus takes the largest market share.

P2P lending is a ‘high risk – high return’ industry. Previous studies suggest some inefficiencies due to the irrationality of market agents. For instance, lenders have more impact on borrowers since many lenders are institutional investors. The market can suffer from illiquidity if these investors threaten to reduce the money supply. The markets are also mostly unregulated by the authorities.

On the positive side, P2P lending platforms succeeded in capturing the borrowers who were considered risky by banks. These groups of retail borrowers include young businesses and self-employed professionals. Moreover, most P2P platforms were able to attract higher quality investors and, with a proper risk management system, succeeded in maintaining an average of 8% returns.

What did I research and how?  In my master thesis research, I asked the following question:

How does the peer-to-peer lending trend coexist with the traditional banking system in the EU?

I wanted to verify whether the peer-to-peer lending platforms compete with the commercial banks or rather serve as a complement thus providing loans to higher-risk applicants. I chose to study the EU region since there was no comparable study that explored this market.

To investigate the research question, I used an empirical model – Difference-in-Difference. I used Basell III requirements implementation as the exogenous shock. The exogenous shock means that the event happened unexpectedly and affected only one group (The treatment group) of all the units considered in the study. In my research, the 2016 EBA stress test served as a proxy for the exogenous shock. This stress test involved 51 banks from different European countries. Therefore, my treatment group consisted of the countries where these banks were located.

I selected three dependent variables (Y), namely, P2P loan size, P2P lending volume and P2P loan duration. The independent variables were the dummies Post, Treatment and Post*Treatment (which is the standard for Diff-in-Diff design). With these dummies, I was distinguishing the before/after effect on treatment/control groups. As control variables, I used country-specific variables such as unemployment level, median income level. Share of systematically important financial institutions, etc.

Discussion of the results. My research highlighted several important conclusions. First, P2P platforms compete with the banks in terms of loan volume and loan size. Alternatively, P2P platforms complement banks in terms of issuing shorter loans. The loan duration on a P2P platform generally does not exceed 2 years.

Second, the results concluded that banks with a stable initial capital level and asset quality could withstand the competition in the lending market.

Finally, this research highlighted the new empirical evidence related to agents’ behaviour in the EU lending market. This evidence suggests that agents are reluctant to use international P2P platforms, whereas they are more prone to use the platforms headquartered in their country of residence.

Last remarks about P2P lending market. Peer-to-peer lending is a very interesting concept for research and application. The industry is still in development and is therefore risky and unregulated; however, it has proven its importance for retail borrowers and for investors. It offers an alternative approach to banking with a fully online environment and data transparency. All platforms offer fair statistics on their performance in terms of investor returns, borrower quality, loan volume and other performance indicators. In my opinion, with more research and the trust of society, peer-to-peer lending can soon play a crucial role in the EU economy.

My experience with investing in P2P. PLEASE NOTE THAT THIS IS NOT A FINANCIAL ADVICE. As a part of my research, I registered on a P2P lending platform Mintos. During the registration process, I was required to verify my identity and answer some questions regarding my income sources. I also completed a test on my finance knowledge, which allowed me to select a passive investment strategy with an expected return of 8% yearly.

Overall, I am satisfied with the experience. My funds were properly managed, even with the recent unfavourable economic events, my portfolio gains were reduced by only 1%. Important to note, the withdrawal of funds might take longer than several days.

To conclude this article, I would like to thank you for your attention and I hope you found value in this article! If you are interested in learning more about my master thesis, you can read the full version of it (available for download below) or contact me directly!