Peer-to-peer lending or social loan sharks?

by Carlos Menezes

First off thanks to Grant for pointing this BBC article out to me. Before I joined him for a smoke-break yesterday (even though I don't smoke) I'd never heard of social lending.

Having been fed this piece of information I returned to my desk and went digging for more. Aside from the obligatory Wikipedia article, I also took a look at two of the more prominent social lending networks – Zopa and Prosper.

Essentially social lending, or peer-to-peer lending, aims to circumnavigate the necessity for a bank. A networking site, such as the two mentioned above, creates a community of money seekers and lenders. Both sites are founded on the same basic principle – people post the amount of money they're looking for, the rate at which they want it and how long they'll take to repay it. Lenders are then able to bid to the borrowers, ensuring a competitive marketplace.

To ensure that these network sites don't just degenerate into a meeting place for loan sharks and their desperate prey, Zopa and Prosper have implemented a number of safety features. Borrowers are investigated and are given a credit rating (of course, the validity of both the investigation and the rating is up for debate), loans over a designated amount are split up among various lenders to reduce credit risk and the contracts entered into are legally binding in nature.

Transaction fees are the primary source of income for these sites, but they can still be viewed as an attractive alternative to banks. The main driving force behind this is that there is direct contact between the borrower and the lender. It's not a case of some faceless institution lending money to anybody so long as they meet their credit rating criteria (or whatever other criteria they have set in place). Borrowers post what they need the money for, allowing lenders to give help to a cause that they believe in. A budding college student can write about his dreams for the future, allowing a more personal nerve to be struck with prospective lenders. As such this can provide much more than just financial rewards for money-lenders, thereby decreasing the rates at they're willing to lend money.

It has been found that the rates achieved by Zopa are generally lower than those offered by banks. Add in the inherent skepticism that people have with regards to banks' intentions (after all, they are in business solely for the sake of profit) and you will see that there was an invitation by the marketplace for sites like Zopa and Prosper.

Whether these sites will indeed prosper or not remains a big question mark. Their potential for success however, is enormous. And if they do succeed then this will surely be the biggest case of taking out the middle-man that modern day business has seen.

For a more detailed breakdown of these two sites I urge you to read through Allen Stern's comprehensive post on the subject.

2007/05/09 | permalink | comments (3) | trackbacks (0)

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