Why Does Lending Club Set The Interest Rates If It’s A “Marketplace”?

| By:

marketplaceA new user on the LendAcademy forum asked a good question.

“If Lending Club is merely creating a marketplace for borrowers and investors, why does LC set the price? Why not let them determine it independently? The external credit models are fundamentally about finding loans with the highest expected return relative to their risk.”

Here are some of the summarized responses that were given:

– Individual investors are not as able to price risk on their own

– It would be inefficient, much more time would be needed to investigate each loan

– Prosper started out doing it this way and the results were poor

– Lending Club doesn’t disclose all the data points to investors for proprietary reasons and to avoid releasing information that could lead to borrower discrimination, i.e. violations of the Equal Credit Opportunity Act (ECOA) and Consumer Credit Protection Act (CCPA). It’s better to have a third party manage these legal risks.

Today, many investors use automated programs like LendingRobot to do their investing for them, which means the hassle of trying to price a loan in a dutch auction with limited information would likely become an obstacle in the marketplace. It would also become a race to the bottom. Underpricing risk would be great for borrowers because they’d benefit from very low interest rates but it would be a disaster for investors that would likely experience losses as a result. If investors were all institutional and accredited, then maybe that would be fine. But since Lending Club has a substantial amount of unaccredited investors, the kind legally presumed to be unsophisticated, putting the onus of pricing risk on their shoulders would quickly lead to the collapse of the system entirely.

Lending Club might not be a marketplace in the purest sense, but given the legal complexities and investor/borrower protection considerations, it comes pretty close.

You can read the original thread on the LendAcademy forum here.

Last modified: April 29, 2016
Sean Murray

Category: Marketplace Lending

Home Marketplace Lending Why Does Lending Club Set The Interest Rates If It’s A “Marketplace”?