Peer-to-Peer Lending in a Flat World
by Balaji Yellavalli, AVP and Head of Solutions, Banking and Capital Markets Business Unit
Recently I visited a website called prosper.com, a site that calls itself “The online marketplace for people to people lending”. Simply put, it is the e-Bay equivalent of consumer finance wherein people who want money post their need on the site and willing lenders then bid to finance all or a portion of that debt. But the simplicity should not be mistaken for the sophistication that lies under the covers.
The prospective borrower lists his or her credit rating (determined by the company, based on past repayment behavior of the person, credit reporting agency evaluation, etc.), debt to income ratio and the interest rate he or she is willing to pay and the purpose of the loan or where the funds are expected to be deployed.
Add to this, other bells and whistles, like the ability to build a portfolio of “units” of debt across categories of borrowers (I believe the minimum unit is $50), or lenders’ ability to pick a combination of risk (e.g., pick only homeowners AND those with verified bank accounts). The company makes money from commissions or transaction fees, akin to e-Bay. Right now, it is a site open only to US Residents. I have heard of another site called zopa.com which serves the UK market.
I think this model offers a glimpse into the future of consumer lending in a Flattening World! I would go so far as to say that this is the emerging model of “peer-to-peer” investing in the Flat World– apparently, some companies are using prosper.com rates of return for certain risk categories to benchmark returns from other classes of investments, including mutual funds, hedge funds, ETFs etc!
Peer-to-peer lending may not be a big force today in terms of transaction size, volume or market share. With loan sizes on Prosper’s site ranging from $5000-$15,000 and a most recently reported annual revenue figure of less than $2 million, it is at best a micro-player. But the fact of the matter is that it is creating a non-traditional and sustainable channel for marginal borrowers or borrowers whose end uses may not be justifiable for a traditional unsecured lender like a credit card issuer. One borrower wants to repair frozen pipes in his home, the other wants to consolidate high cost credit card debt…and hold your breath, a third wants to reinvest in the company, borrowing others’ money!
Peer-to-peer lending is attracting a distinct category of borrowers and investors, who keep returning, based on their positive experience. It offers a compelling model with the potential to challenge established players in the so-called “sub-prime” lending space. No wonder that a client of mine, the CIO in charge of e-Commerce for a large Bank, recently mentioned that business models like peer-to-peer lending are the biggest threat to traditional, organized financial services industry!
Comments
This seems very interesting, I read an article on Prosper.com at Businessweek.com, "Prosper: The eBay of Loans?". Although, one needs to be a little skeptical about such services as there is a chance of default and scammers, eBay has proved everyone wrong with a virtual community model that keeps check on the defaulters through peer reviews (as in bad or good rating). I am sure this model will have takers but I don't think this model will affect traditional financial lenders for a while. It's a good model to study peer to peer lending in a virtual world though.
Posted by: Jasjit | March 14, 2007 06:47 PM
This sounds superb never knew such a thing existed at a formal level
I think the model is kind of a micro finance, which works best with people who have some amount of surplus funds to invest. But in India there are many traditional channels of funding, which though do not operate through a virtual platform do have much presence among the society. These include moneylenders, chit financers, daily finance business etc. Even among the traders a lot of cash traders happen among themselves with some minimum of margin. There is of course informal intermediary in between who charges some commission. I am banker working very closely on the microfinance platform, I feel This model however has some constraints in terms of growth to a larger level since as the volume and ticket size if transactions increase we would again require modern and traditional risk mitigant to ease out the risk scenario from any exposures. So, if that happens we actually end up coming full circle to the banking domain itself which has its strength in formal transactions and risk mitigant mechanisms. Since contrary to other assets money is highly fungible in nature which exposes it to typical risks which can be mitigated only though formal techniques
Posted by: srihari adurty | March 19, 2007 04:49 AM
This seems to be very good model.If the loans are covered via insurance,the model gives the freedom to lend money here. By providing insurance/underwriting the loan Prosper can have more revenues.
Posted by: sivamangesh | March 22, 2007 07:01 AM
Peer to Peer lending is not new but what is new is web based tools for such transactions. Peer to Peer lending is very big in India. In fact, most of the small businesses are funded through it.
Posted by: Rajiv Shethia | March 26, 2007 12:40 PM
In addition to Prosper, there are several other P2P Lending players entering the space...
In early December, LendingClub.com opened their (formerly FaceBook users only) lending application to the wider public. They partnered with WebBank to ride under their national charter (the other players have pursued a state-by-state licensing strategy, which sometimes constrains the rates or amounts of loans they can make). LC does things a bit differently than Prosper, as they underwrite the loans (ie, bucket by credit grade and set interest rates for each bucket). They have a 640 FICO minimum for borrowers, as well as a max. 30% DTI, so it might turn out to be a better pool of borrowers.. plus they have a $25 minimum bid, which means you can diversify into twice the number of loans (in contrast to Prosper’s $50 minimum).
Zopa.com launched in the US in early Dec, but it’s nothing like their original UK version and is oddly “un-P2P”. Lenders buy into a 5.1% guaranteed CD, and, from what I can tell, Zopa pockets the rate-spread between 5.1% and whatever they charge borrowers (up to 17% or so). Other weird stuff about their model, as well, including a mandatory “help” (ie, you have to donate of part of your return to at least one borrower).
Loanio.com is scheduled to launch in Jan ‘08, and, while not much is known, seems as though it may tend toward a more free market / auction-style P2P marketplace, similar to Prosper.
Side by side comparisons, etc, at: PeerLend: Peer to Peer Lending Information
Anyway, fun to watch the space - and easy to see why this kind of thing is on banker-radar.
Posted by: PeerLend.com | January 3, 2008 09:30 AM