The marketplace lending industry has been touted for many years for providing increased credit availability to under-served borrowers. In fact, this is one of the reasons the industry came to exist. Over the last decade, as banks backed away from making small dollar loans due to a variety of economic and regulatory constraints, marketplace lending platforms have stepped in to provide credit to borrowers who otherwise would not have had access (except perhaps at great expense).
A new study, “The Effect of Usury Law on Higher-Risk Borrowers,” confirms this theory and also points to credit availability being hampered by recent case law, Madden v Midland, which is effectively limiting credit availability through usury caps in three states: New York, Connecticut, and Vermont.
The study points to three principal findings:
“First, we show that Madden led to a decrease in the volume of loans issued to higher-risk borrowers in the three Second Circuit States…We show that Madden’s effects are consistent with this intuition: constrained by suddenly effective usury laws, lenders provided relatively less credit to lower-quality borrowers.”
“Second, we examine whether borrowers in the Second Circuit responded to Madden by strategically defaulting on outstanding marketplace loans that have potentially usurious interest rates. Although we explore that question by way of several specifications, we find no evidence that Madden led to an increase in strategic defaults, despite the fact that the decision rendered many marketplace loans potentially uncollectible.”
“Finally, we consider the effects of Madden on the trading of marketplace loans—and notes based on such loans—in secondary markets. We show that Madden led investors to apply a larger discount when purchasing non-current, potentially usurious loans to borrowers in the Second Circuit.”
On this last point, the study also importantly points out that current loans for sale from Second Circuit states did not see a larger discount than normal. This is an important distinction showing that investors expect these borrowers, who are currently making their payments on time, to continue to do so – even though their loan may no longer be legally enforceable. Just as interesting on that point, the study finds no increase in strategic defaults on potentially usurious loans.
Overall, the study provides significant evidence of decreased credit availability as a result of strict usury caps, as well as fascinating insight into borrower and investor behavior around these caps.