We quantify the competitive implications and welfare effects following the entry of online Peerto-Peer platforms (P2P) into local banking markets in Brazil. P2P lending is among the fastest growing segments in modern financial markets, and its interaction with banks has gained attention in the finance literature (see Thakor (2020)) and among financial regulators (Nemoto et al. (2019)).

Naturally, when a new competitor arrives, existing lenders may react. However, little is known about the competitive response by banks or about the spillover and welfare effects of a new competitor in the banking sector. This response can be particularly evident in markets where banks hold a lot of market power, like in most emerging economies.

To do so, we use data on virtually all working capital loans from banks and P2P platforms to small businesses in Brazil from 2016 to 2020. Our empirical strategy is twofold. First, we take advantage of the vast banking market heterogeneity to match the municipalities where P2Ps issued a loan with similar ones without P2P loans, allowing us to estimate the local effects from P2P entry accurately. Second, we exploit the local introduction of optical fiber internet as a quasi-natural experiment enabling P2P entry to confirm the previous estimates. Our main contributions are: (i) to identify the reaction from incumbent banks caused by the P2P platforms’ arrival and (ii) to estimate a structural model of the banking sector to quantify the elasticity of loan demand and calculate welfare effects. We find that the competition between banks and P2P lenders is a first-order effect depending on the number of local lenders.

The main results are as follows. First, we document that P2P lenders predominantly focus on firms with a preexisting relationship with banks, offering them four percentage points (pp) lower risk-adjusted rates. More importantly, after a firm borrows from a P2P platform, they are able to find a 1.4 pp lower rate on subsequent bank loans. This result indicates that banks view P2P platforms as a valid competitor - in accordance with previous findings in the literature (see Tang (2019) - and try to regain runaway borrowers. Second, we turn to the municipality-level analysis to find that P2P entry triggers significant local spillover effects in concentrated markets.

Incumbent banks respond to the P2P competition by reducing interest rates by 3 pp 1 and increasing the volume of loans in reais (R$) issued per firm by 7%. Existing firms with difficulty accessing credit are the ones that benefit from this scenario instead of new firms. Third, social welfare increases monotonically with the number of existing lenders. The effect ranges from 10% of the local output in the municipalities with only one incumbent bank to 1% in those with five banks.

In less concentrated municipalities, the welfare gains are close to zero. Our findings indicate that P2Ps play a pivotal role in reducing credit frictions in oligopolistic markets.