An article in the Wall Street Journal noted that online peer-to-peer lenders “have automated the processes of checking borrowers’ credit metrics and looking up their histories while in many cases avoiding more labor-intensive practices of collecting and reviewing pay stubs or tax returns.” The article also noted, “Charge-off rates, which reflect loans on which a lender doesn’t expect to collect, have risen.”
a. Why do banks require borrowers to submit pay stubs and tax returns when applying for a loan? Why would online lenders skip this step in the loan application process?
b. If online lenders find that borrowers are defaulting on loans at higher-than-expected rates, can they offset the problem by charging higher interest rates on the loans? Briefly explain.