When seeking a loan, individuals have traditionally turned to banks and loan officers, engaging in a face-to-face interaction at a local branch. However, an alternative option has emerged in the form of peer-to-peer online lending platforms such as Prosper.com or Kiva.
These platforms facilitate the publication of loan requests, which are then funded by interested investors, whether they are individuals or companies. Unlike bank loans, where funds originate from the financial institution, peer-to-peer loans derive their capital from a collective of investors, many of whom may share similarities with the borrower.
The attractiveness of an individual’s loan request to potential investors typically hinges on factors such as a favorable credit score and a reasonable loan proposal. Nevertheless, what if the level of investor interest is influenced by the borrower’s geographical location, specifically whether they reside in a politically red or blue state?
Ideological lending
This intriguing question formed the basis of a study by the Georgia Institute of Technology. The study sought to examine whether an investor, situated in a state considered politically red, would exhibit a greater inclination to fund a loan request originating from another red state, as opposed to one from a blue state.
To explore this question, the researchers utilized data obtained from the peer-to-peer lending platform prosper.com, spanning the period from 2006 to 2011. Various analytical models were employed, including a gravity model and a difference in differences (DID) model that assessed investors’ reactions to the legalization of same-sex marriage in California.
The findings of the study revealed a nuanced effect. Specifically, when the investor’s state exhibited a more conservative political leaning than the borrower’s state, lending offers declined by up to 11.6%. In contrast, when the investor’s state leaned more liberal than the borrower’s state, no significant relationship was observed between political alignment and lending behavior.
Like with like
“When California legalized same-sex marriage, we found that investors from most states reacted by issuing more lending offers to California borrowers, except for investors from states with much more conservative political ideologies,” the researchers explain.
“The difference between investors from liberal and conservative states relates to an ongoing debate in the psychology literature,” they continue. “The ‘prejudice gap’ hypothesis posits that conservatives are more intolerant of liberals than vice versa, whereas the ‘ideological conflict’ hypothesis posits that conservatives and liberals are equally intolerant of each other. Our results are consistent with the ‘prejudice gap’ hypothesis.”
The researchers’ findings highlight an intriguing phenomenon: borrowers residing in states with more liberal political leanings than the active investors on the peer-to-peer lending platform faced greater difficulties in securing funding for their loans. This outcome had a tangible impact on the platform’s primary function, as fewer loans were successfully funded.
Political differences
The researchers emphasize the disruptive nature of the negative effect stemming from political differences, noting that it hindered the platform’s fundamental purpose. Loans from borrowers located in politically distant states encountered challenges in attracting investment, thereby impeding the flow of capital through the platform.
Interestingly, the researchers discovered that this political distance effect was not evident among experienced investors. As Professor Wang explained, the researchers observed that the political divergence between borrowers and the group of investors financing their loans did not significantly impact the repayment performance of these loans. It is plausible that seasoned investors, with accumulated experience, gradually learned to disregard a borrower’s presumed political ideology when making lending decisions.
The implications of the research extend beyond the realm of peer-to-peer lending. They shed light on the detrimental consequences of political polarization, highlighting the difficulty of finding common ground even on basic factual matters. The study’s findings demonstrate that the adverse effects of polarization permeate into the domain of peer-to-peer lending, particularly among inexperienced investors.
“The issue we document is not unsolvable. It goes away with experience, likely as investors learn that differences in political ideology don’t predict loan performance,” the authors conclude. “We think education from peer-to-peer lending platforms about the factors that do predict loan performance can substitute for this experience.”
