How Does Online Lending Influence Bankruptcy Filings? Evidence from a Natural Experiment

Abstract

By providing quick and easy access to credit, online lending platforms may help borrowers overcome financial setbacks and/or refinance high-interest debt, thereby decreasing bankruptcy filings. On the other hand, these platforms may cause borrowers to overextend themselves financially, leading to a “debt trap” and increasing bankruptcy filings. To investigate the impact of online lending on bankruptcy filings, we leverage variation in when state regulators granted approval for a major online lending platform – Lending Club – to issue peer-to-peer loans. Using a difference-in-differences approach, we find that state approval of Lending Club leads to an increase in bankruptcy filings. A complementary instrumental variable analysis using loan-level data yields similar results. We find suggestive evidence that the ease of receiving a Lending Club loan causes some borrowers to overextend themselves financially, leading to bankruptcy. We also find that “strategic” borrowing – in which borrowers who are considering bankruptcy use a Lending Club loan to restructure their debt or to engage in last-minute consumption before they file – may play a role. Our results suggest that recent initiatives from online lending platforms to control how borrowers use loans, such as Lending Club’s Direct Pay program that sends loan funds directly to creditors, can help these platforms provide safe and affordable credit. Our study adds to the literature that examines how online platforms influence society and the economy; it contributes to the literature that examines how financial products, services, and regulations influence bankruptcy filings; and it has policy implications for online lending design and regulation.