Is Peer-to-Peer Lending Worth The Hype?

There's growing excitement surround so-called peer-to-peer (oh, sorry, p2p) lending exchanges that are supposed to do for finance what eBay did for selling Pez dispensers and knockoff purses.  Here's a profile of a company called CircleOne, and here's an existing company called Zopa, based in London, which among other things, offers you free wine if you sign up to be a lender.  Basically, these companies match up lenders and borrowers directly, ostensibly cutting out the middleman.  There's something naturally sexy about this, so we wouldn't be surprised to see this area see more entrants in this area.  Here's a quote from their website: "Zopa is aiming to offer banking products on a human scale, offering an alternative to a world characterised by automated systems and mega profits."

Oh, how populist of them.  But, does the concept make any sense?

Consider that for the most part, banks are already peer-to-peer lending institutions.  The deposits held in our checking and savings accounts, and CDs is the capital that banks have available to lend to people for their house, new kitchen, new car, or college education.  Now obviously, most banks have become way more complex than this simple model, but at their core, this is fundamentally what a bank does.   The interest rates on loans and deposit are supposed to dynamically keep a balance of deposits and loans.  Of course there's a spread between what a depositor gets (say on a CD) and what a borrower pays, which goes to the bank, but there's no way that a Zopa could eliminate the concept of spread.  Somebody will have to pay for enforcement, loan collection, monitoring credit scores and borrower background, working out alternative payment scenarios, if the borrower is close to default, repossessing colatteral, auctioning collateral, etc. etc.  Unless, Zopa, or CircleOne can figure out a way to eliminate these costs, then it's hard to see what advantage they'd offer over a traditional bank.

This isn't to say that traditional banks don't have bloat or other wasteful costs.  There's something to be said for internet-only banking, and the cost-savings of not having physical locations.  Obviously, this will be an area for major cost-cutting in the future.  There are probably some fees and penalties that would be reduced with better competition as well.

These exchanges might attract some people who are attracted to them for philosophical or aesthetic reasons, but they are not going to dramatically alter finance the way online auctions, or file trading did for their respective industries.

Update: Asaf Buchner of Jupiter Research has a review of his experiences with an exchange.  It sounds like a big hassle without much reward.

Comments

[Albert Drouart]

Thanks for a great blog! In regards to P2P lending: Isn't it true that this kind of lending is another higher-yielding, higher-risk opportunity for those of us with some cash lying around? It's a different kind of experience versus day-trading, for example, that could lead to higher returns. I think that makes it interesting in addition to what you've stated.

[J. Russell]

CircleOne changed their name to Prosper. Prosper is the service Asaf Buchner is discussing in his blog.

[Josh]

Gee...Thanks for that unbiased review. Perhaps you should stick to that 2% return at your favorite local bank.

[Astoria NY]

I've been using Prosper since the beginning and so far havn't had any trouble. I've got about $1k in it so far and everyone is paying on time. I think the model has potential.

[Tomboy]

Great review!!!!! People lending to strangers mmm,,, yeah ok...

[Ronson]

It is this simple banks don't lend to people with issues, peer to peer offers these people opportunity to get money they need. At the same time there are Group leaders who are interested in helping these people move away from debt. It is a more personal experience if you end up in the right group. In addition I currently have CD's that carry 5.5 APR on them great, Inflation is what averaging 2.5-3.5 % yearly so my real return is close to 2% I have treasury bonds that do better because they are indexed to inflation. Anyway, if I loan my money to my credit union I get 5.5 % however they are loaning that same money out at 8% + and if it is car loans many are going at 12% and then the credit and signature loans exceed 18 %. So for every 5.5 I make my credit union takes up to 12.5 % not to mention they get to keep all those late fees. Or I can chose to loan my money out responsible to high credit individuals with low ratios at 9% yeah the company that is doing the work is going to take about 1-2% so I am looking at only 7%. Now let me think is 7% better than 5.5 % yes am I taking more risk yes. Risk is the only issue.

[Joe Bob]

Let's review the facts here... CD rate of 5.5%. FDIC insured that I'll get my money. 12.5% here... who the hell am I lending to? Banks have had hundreds of years of experience in understanding the vast matrix of risk analysis with hundreds of MBAs on payroll. Joe down the street with $5000 extra is going to know how to lend his hard earned money? Yes, day trading is risky, but the risk is yours, the exchange will not screw you. If you buy, you WILL get your shares. Not the same here.

I want to short this thing...

[Martin Smith]

There is something here in P2P lending. We all know that banks are losing touch with us. Their most creative efforts seem to be in how to charge new fees for services we really don't need. Certainly the irony can't be lost on anyone that we get 5% on our deposits while they charge us 19% or worse on our debt. What a spread, what a rip. That kind of spread has so much unreasonable room that it is begging for someone to put it to sleep. The other thing I want to see torn down is the secret society of Venture Capitalists. Can that be far behind? Hope not. The central point of the web is that any business that can be created will be and this idea may be the next Ebay. Why would you want to miss that train again?

[Craig T]

So far everyone's complaint about P2P is that you're lending to a stranger(which cracks me up because you don't know the people you're lending to in a traditional bank setting either). The obvious risk in P2P is that people don't pay, but just like any other investment, you want to diversify your money among several borrowers.

Less-than-average Joe may not know that, but there is a peer lending company on the horizon that does two things to combat that...

1. the company makes sure that your "deposit" is spread out among several borrowers based on your risk tolerance.

2. the company finds an outside party to insure each loan.

I'm sure its just a matter of time.

[Bob]

To be upfront, I'm affiliated with a new P2P financing company called FYGO, which addresses a number of the issues brought up in this string.

While its technically in the same area, FYGO's a very a very different model... and can be summarized as "LinkedIn meets PayPal".

At FYGO, you create networks of people you know and trust, enabling the members of your network to help each other out by lending part or all of the money needed by another member within the group.

A benefit is the fact that the "awkwardness" and emotional angst associated with borrowing from and loaning money to your family members or friends is removed by the automated, electronic, web-based system that FYGO provides.

It allows borrowers to acquire short-term cash at a fair interest rate, no FICO score required. For lenders, you can help people you know and trust when they need it most...PLUS earn a fair return - hey, what's wrong with that?

[FinEcon2007]

It seems that a few people are missing the point of the P2P networking potential and are too iconoclastic concerning the role of the bank. For example, when was the last time that FDIC actually saved you from a defaulted loan? I believe that this argument is overstated. While yes it is there, some of these P2P offer insurance on their loan investments as well. Another example, whether you invest in a bank , which gets more use of your money that you do, you still are incurring some level of risk. You don't think that the bank too invests in risky ventures? What about that start-up business loan or the guy asking for a loan who has three different jobs in three months? Lastly, these P2P websites offer short-term loans as well with smaller amounts that a bank. Banks have a minimum loan amount and repayment horizon. Provided this business model becomes more refined through competition, as it does it will do more to bring capitalism to the average American for both investments and lending that does a bank.

[Harbinger]

I think P2P lending is awesome and I expect companies like Prosper Marketplace to find a way to get into the credit card business eventually too. Imagine bankless credit cards! =)

The only issue that worries me is that P2P doesn't involve fractional reserve banking which is what our monetary system is based on. You see, every time a bank creates a loan, they don't transfer the money from somewhere, they create it right then. As more people turn to P2P loans instead of banks, the rate at which money is created will drop and that will have a contracting effect on the money supply.

The expected result will be deflation, which means the purchasing power of our money will incrase. Most people wouldn't have a problem with that at first but, the Fed won't have the power to compensate for excessive deflation and, it could lead to economic instability unless proper steps are taken to reform our banking and monetary sytems.

And we need to start now, not wait for everything to go to hell in a handbasket.

[PeerLend.com]

A brief update:

Prosper has since originated over $100mm in loans, with a member base of over 500,000.

Zopa (who, at the time of this article, operated only in the UK) has launched a US version in partnership with six US credit unions. The model is not quite "P2P", as lenders are asked to purchase a guaranteed CD (~5%), the purchase proceeds of which Zopa will lend out to borrowers (presumably pocketing the spread).

LendingClub.com, a completely new player, entered the space, via the FaceBook social networking platform, and has just recently opened to the non-facebook public. Their platform is P2P, but it differs from Prosper's more laissez faire implementation in that LendingClub underwrites the loans, bucketing them into different grades at different rates - doing away with the typical auction process.

Information on this space, including side by side comparisons of players, at:

PeerLend: Peer-to-Peer Lending & P2P Loan Reviews

Two more market entrants are apparently ramping up for launch, as well: GlobeFunder & Loanio. The former is in limited testing in a handful of states, the latter in stealth mode, but supposedly scheduled for launch sometime in January '08.

In addition to the US for-profit players, there are also are several non-US focused, more "social finance" oriented, services popping up. Notably, eBay has recently made an investment in MicroPlace, a microlending operation that allows investment in developing nations.

[Disco Valante]

I am starting a small business, www.discovalante.com. Are P2P sites good for businesses?

[J Dawson]

After all the press releases about peer lending being the future, it's interesting to see how fast things are beginning to spread and catch on. Another new one I have found is www.FundMyNotes.com
Haven't heard much information about this one yet, but it lists that it should be due out sometime in 2008.