How low can you go? — Overcoming the inability of lenders to set proper interest rates on unsecured peer-to-peer lending markets

• Peer to peer lending markets offer a promising alternative to provide risk capital.
• We study myc4.com, a platform serving African small and medium sized enterprises.
• We show that market prices for capital hardly reflect the associated default risk.
• We present a model to assess borrower default risk using publicly available data.
• We show that model based decisions result in significantly higher returns.

The lending of money is traditionally handled by banking institutions. The internet has enabled new forms of credit businesses, challenging the classical bank loan. Peer-to-peer lending markets bring together noninstitutional borrowers and lenders. In a typical lending market, borrowers have to present their projects, and lenders decide under what terms they are prepared to provide the requested capital. As many loans are not secured by collateral, the assessment of the creditworthiness of the borrower is the most important task.We demonstrate that investors fail to transform the available information into proper market activities in the absence of hard, quantifiable banking data, threatening the sustainability of this new lending concept.We present a decision-support-tool to support users in the estimation of risk of default. Based on an a-posteriori analysis, we demonstrate that our system is able to price the risk of default adequately and is able to improve investors' return significantly.