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Forward Looking Versus Backward Looking: An Empirical Study on the Effectiveness of Credit Evaluation System in China's Online P2P Lending Market

A failure of credit evaluation results in increasing default risks in the online P2P lending market. Online P2P lending platforms use both forward-looking and backward-looking credit evaluation mechanisms to assess the credit levels of borrowers. The forward-looking credit evaluation mechanism (FCEM) judges credit levels of borrowers with the uploaded information while the backward-looking credit evaluation mechanism (BCEM) uses the historical repayment performance of borrowers on the platform to assess the credit levels of repeated borrowers. Since not all information uploaded by borrowers reflects the credit ability and the trueness level of borrowers, only the hard information that reflects the credit ability can explain the default risk on the platform under the FCEM. The BCEM based on repeated borrowings produces both promise-enhancing and “fishing” incentives and thus does not significantly reduce the default risk, and weakens the effectiveness of forward-looking credit indicators in explaining the default risk because it encourages borrowers to invest in forging forward-looking credit indicators. Additional information such as the interest rate and the repayment period reveal borrower’s credit and thus can also be used as predictors of borrowers’ default risk. Borrowing data from the Renrendai.com are used to test the effectiveness of various credit evaluation mechanisms.