Adverse Selection in Credit Certifications : Evidence from an Online Marketplace Lending Platform

Certifications are an important signaling device for attenuating information asymmetry. This study examines their role on a Chinese online marketplace lending platform, which grants certifications to borrowers after they submit the necessary documents. Although the platform verifies the certifications, they are easy to obtain without many access barriers. Our findings suggest that certifications increase funding success rates, particularly for lower quality loans. The minimal standards mean that certification costs are the same for all borrowers, regardless of creditworthiness, which violates the requirement of costly signaling. This gives lower quality borrowers an incentive to obtain more certifications, leading to adverse selection. We also demonstrate that more certifications are associated with worse repayment performance for funded loans, indicating that certifications suffering from adverse selection are unable to accurately signal borrower quality. Our evidence further highlights adverse selection as a key factor in the failure of certifications