The Do Well and Do Good Potential of Peer to Peer Lending

I often talk about how access to capital is one of the basic human needs for building a better life. So I've been tangentially following the online peer-to-peer space because it promises to help provide capital particularly in instances where traditional channels for loans (such as banks) might fail.

 

P2P lenders create online marketplaces or tools that connect individual borrowers to individual lenders. In so doing they provide individuals access to credit and capital that otherwise might not be available to them and at rates that theoretically can be better than what the banks would provide since they are 'cutting out the middleman'. Sites like Prosper, Lending Club, and Zopa enable P2P lending between pretty much any borrower and lender. You can actually go on their sites and look for individual loans to 'invest in' based on target returns that you want and the borrower's credit worthiness. Virgin Money has taken a somewhat different approach. Instead of enabling lenders to make a loan to any borrower, they focus on facilitating the informal loan process that often already exists between families and friends. Basically, they help borrowers formalize and administer loans they get from people they already know.  Finally, players like Fynanz focus on just a specific segment of the loan market, in their case being student loans.

 

But for all the wonders and promises of this new source of capital and credit, there are some key remaining questions about how P2P lending can and will move forward that will likely determine the true economic and social value of this space.

 

First is the question of how big an impact P2P can actually make. While it is clear that the Prosper/Zopa/Lending Club model has potential to bring larger amounts of capital into this space because it is not constrained by the borrower's personal network, it also raises the question of if these models will lead to ill-advised borrowing and speculative lending. And even outside these concerns, can this model really scale without going to the traditional capital markets to supply the funds needed for loans? In this light even the Prosper model has a glass ceiling on how big it can grow in my view. If that is true, what is or can be the real economic and social impact here?

 

One powerful idea is that P2P loan histories could be a useful proxy for credit worthiness for someone who might otherwise not yet have a credit history and not yet be able to access more traditional loan products. The assumption here is that if you can actually capture the 'informal' loans that are often made between family and friends or via P2P you can really smooth millions of people's transition to joining the traditional credit-worthy world. This is especially important since it is often those who are ignored by the traditional financial institutions that are making and taking these informal loans.

 

In this light, then, the most interesting question is how P2P eventually integrates into the traditional financial framework. Another example of this integration might be around what traditional banks might learn about assessing risk from the P2P loans. Should the social networks and social capital that are being tracked by these sites be integrated into the calculation of credit risk? Does a low default rate for a loan from a family member or friend translate into better credit risk overall?

 

Finally, before all this moves forward the P2P industry as a whole (at least in the Prosper model of linking most any borrower to any lender) needs to figure out if it is selling regulated securities. While Lending Club has taken the view that they are selling regulated securities, Prosper and Zopa have not. I couldn’t help but notice then that on the New York Times Freakanomics blog post about P2P there were a lot of disgruntled former Prosper lenders claiming that the site's practices aren't totally above the board. The fact that Lending Club is part of the regulated SEC regulated process means that their practices will be subject to external audit and regulation, perhaps lending an air of credence to their default rates and other information that will be necessary to take P2P to the next level.

All in all, it's a fascinating space with some key challenges ahead. I'm hoping they get solved in a way that truly enables the social power behind the idea.

Comments

[Loans]

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[Anagha (cheap loans)]

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