Adverse Selection and Credit Certificates: Evidence from a P2P Platform

Abstract

Peer-to-Peer lending platforms encourage borrowers to obtain various credit certificates for information disclosure. Using unique data from one of China’s largest Peer-to-Peer platforms, we show that borrowers of lower credit quality obtain more certificates to boost their credit profiles, while higher-quality ones do not. Uninformed credulous lenders take these nearly costless certificates as a positive signal to guide their investments. Consequently, loans applied by borrowers with more credit certificates have higher funding success but worse repayment performance. Overall, we document credit certificates fail to accurately signal borrowers’ qualities due to adverse selection, resulting in distorted credit allocation and investment inefficiency