Can Peer-To-Peer Finance Work?

Dotnaught writes "Two companies, Prosper and Zopa, appear to be convinced that social networking can be combined with borrowing and lending. They're intent on using eBay as a model for listing and bidding on loans without the involvement of a bank. Call it peer-to-peer finance. There are already some 800 groups on Prosper ready to loan money to specific causes, such as the Apple User Group, 'a lending group for those wishing to purchase either a Macintosh or Apple iPod.'"

Existing Finance

I can't imagine how this is able to compete with existing financial providers.

First of all, how many bad debts can these peers handle? Large corporations have enough cash to handle bad or delayed debts.

Unlike other successful P2P services, this model is entering a market where existing businesses are making a living out of it.

Re:Existing Finance

Peer to Peer financing has been around for decades. It is called a Credit Union.

Re:Existing Finance

These businesses may be entering a market that's already full of competition but I think the main idea is that regular people can loan small amounts of money, together effectively becoming as large a business as the existing businesses -- although the profits may be smaller, people aren't doing it for a living. Each person is giving a little, but they can effectively compete with large companies. (And losing $100 or so won't hurt the types of people who will invest money into P2P loans).

Although it might not be as large a benefit to investors, it could increase competition in an already competitive market and help borrowers to secure better loan terms. Hopefully, this could also help out people with poor credit ratings as there are more potential businesses to loan them money.

Similar to Angel investors vs VCs

There are plenty of rich guys willing to study "small" deals that existing financial providers won't deal with.
Two obvious examples are

• Angel Investors that fund many companies that VCs and Investment Banks don't. They make their money because they're willing to study complex opportunities that may be close to their area of expertise, and
• the other obvious example is the mob, who gets higher interest rates and can afford to take on riskier loans because they have a more effective collection agency.
  

And it's hard to underestimate the stupidity of some lenders. I imagine there are plenty of people with a lot of money who will seriously consider lending to a high-school kid to get an XBox in the same way that they consider lending to former Nigerian Royalty to help them get millions out of there.

Re:Existing Finance

I can't imagine how this is able to compete with existing financial providers.

Yay, venture capitalists!

First of all, how many bad debts can these peers handle? Large corporations have enough cash to handle bad or delayed debts.

They are trying to spread ris

Re:Existing Finance

I can't imagine how this is able to compete with existing financial providers.

If you aren't completely risk-intolerant, it looks far better a place to put money than a bank for a small investor.

For a borrower, I don't see much advantage, though the terms may be slightly better. I think the lenders are what will drive its success, since having the money to lend will, itself, make it attractive to borrowers.

First of all, how many bad debts can these peers handle?

Zopa lets you limit your exposure to any given borrower to as little as 10 pounds, Prosper does something similar with a a minimum of US$50. Automated aggregation allows spreading the risk.

Unlike other successful P2P services, this model is entering a market where existing businesses are making a living out of it.

Successful P2P services have done that, too. "Buying and selling goods" is, after all, something business were making a living at (even using auction models) long before eBay.

In a sense this is an eBay system for buying and selling money, which actually can work far better since its a uniform, fungible commodity that allows spreading the risk. (Its a little bit different, since the auction service here also covers fulfillment, which isn't necessarily the case with eBay, but that's better for users, since it offloads much of the risk of dealing with a difficult person at the other end.)

Re:Existing Finance

Also unlike other successful P2P services, this model is trading in scarce resources from an economics point of view.

Re:Existing Finance

Hmm...

Speaking as someone who is committing money to a community bank [communitywiki.org] with roughly $2,000 in it, I think the thing is that people trust their own culture, and are more willing to accept risks and lend money within their own culture. People tell each other things amongst themselves, that they do not necessarily tell the banks.

If you lose, it was "for the cause," anyways. If you win, you've aided the cause.

The bank might not even be willing to talk with you.

I know a girl, she's going to college. She needs $50,000 for 4 years of loans. The banks aren't talking with her, and her parents are opposed to her going to college out-of-state. (Read: The parents want to keep her near, to better control her.)

If my culture were just a wee bit more organized, [communitywiki.org] I'm sure we'd have her in her preferred college. (UCSD, I believe.) As it is, we only have $2,000 amongst ourselves.

If only she were going to college in 4 years...

You may also want to check out the concept of Internet Bonding. [communitywiki.org] Basically, if you can look at all the things a person does online, says online, follow the ups & downs in their life, and so on: You can do interesting things with that. You can better evaluate risk. So, if you're operating within your culture, things get a lot easier on you.

In the case of this girl, she has an easy time explaining to us who she is, where she's coming from, and so on: You can see her last few years of work online. "Trustworthy!" we say, "Get that woman her CS degree!"

If only you can book those loans as revenue...

that's how Enron worked.

• CEO makes new subsidiary -
• parent and subsidiary loan each other a couple billion - book them as revenue
• profit
• go to jail

Re:If only you can book those loans as revenue...

Unfortunately, step 4 seems to have been skipped.

Amazing!

Sounds amazing!

One of the drawbacks with banks et al is the insertion of the thick layer of bureaucracy between the lender and the lendee; its expensive, time consuming and impersonal.

If you have direct contact mechanisms like this, people find information

Re:Amazing!

There's good reason why there's so much regulation of banking & finance. It used to be a free-for-all, with rampant fraud on both sides: borrowers and lenders. Do you really feel confident enough not to be fooled by fraudsters of various sorts? It's sort of like phishing, only imagine you are computer-incompetent, because I doubt your (and my, and most people's) understanding of finance is good enough to detect the more sophisticated financial fraud out there. This is like a honeypot for thieves of the worst sort, because there's no tangible goods involved anywhere, it's just money - numbers in people's accounts.

Re:Amazing!

To be honest, I know well I can trust the main banks

Study history. The ONLY reason you can ay that is because of regulations. Look back at the 30s- respected banks went out of buisness as much as anyone else.

I'm not competent to tell what banks are trustworthy. I'm not competent to tell what food won't give me botulism. I'm not competent to tell what products will do what they're supposed to and what won't. I'm not competent to understand cutting edge medicine. I may be able to pick up 1 of these, but there's a limited number of hours in the day- I need to keep up on my primary profession as well. And I'm at the high end of the intelligence curve, I'm far more capable than the average person. The average man would be completely and utterly fucked.

The government regulations are the only thing that enables me to go down to the store and have faith in my purchases. Without that, the economy falls apart. Government regulations are a good thing. Regulations on banks are a damn good thing, they ensure my life savings are safe. There's a reason why prior to regulation most people kept their money under their mattress or someplace similar- they couldn't trust banks. The world is a better place for these changes.

Re:Amazing!

My fear is that the State will barge in and regulate this to its death

That's no fear. It's a FACT! Through the IRS, they will get their cut at gunpoint.

Welcome Back

With this announcement, we are now officially in an economic bubble.

I wouldn't want

to just jump into the lending business. It only works if you've got the legal muscle to force people to pay out. What goods it do to have a million dollars in assets if it's all money owed to you by deadbeats who know you can't take them to court. Then again, if you could lend the money out at high interest and then sell the notes to debt collection agencys who _did_ have the legal muscle, that might work.

Re:I wouldn't want

I think this P2P Finance will only work if P2P Muscle is also implemented at the same time.

Imagine if you can log on to BeatTorrent, hook up with a few peers living near your debtor, and get them to show your debtor some muscles.

credit checks?

Unless there are credit checks people will use this borrow money when they're desperate. Sounds like a recipe for disaster to me.

Re:credit checks?

I can't speak for Zopa, but I've been looking into Prosper. It's quite interesting actually.

There are indeed credit checks. Users have their credit scores checked, and their 'ebay applications' show their rating, broken down into AA, A, B, C, etc. Users also attach checking/savings account when they create their accounts, and monthly collections are automatic. Obviously that doesn't preclude the possibility of defaulting on the loans, but it helps.

Also, there are affiliated collection agencies for defaulted loans. Just as banks outsource collections to agencies, so can you. I've actually recently signed up as a lender, and will be trying things out with a small amount of money in the next week or so.

Please be careful!

I checked out the site, and these were my reactions to it:

The borrowers post what they need the money for, and their stories are identical to the stories I hear every day about why a tenant's rent money is unavaiable/late/whatever. There are some people out there who actually will come up with the rent money. There are some who really intend to come up with it, and believe that they can come up with it, but are unable. There are some who never intend to pay for what they consume and are just good at making up stories. Please, please be careful!

Be sure to spread your risk across many borrowers. When (not "if") one defaults, you won't lose your entire investment.

Be careful of people who, within the last few months, just had a major financial hardship (divorce, medical problem, job loss, etc.) I'm not talking about someone who had the problem 2 years ago and has his/her life more or less back on track... but the FICO score isn't up to where it should be yet. I'm talking people who are in he midst of financial turmoil. It's very tempting to take pity on those people because they are in trouble. Just make sure you are playing with money you can afford to lose. Their FICO and D:I may look ok now, but it's possible that their defaults on their obligations haven't caught up with them yet.

Before you lend any money, please become extra familiar with what the various FICO scores mean and what the debt to income ratio means. Those are the only verified pieces of financial info that you're going to get from the site. A good credit score but high D:I is a very risky loan. Be careful.

Make sure you're getting a good rate on your loans! You can get a 10% average return with an S&P 500 Index [yahoo.com] investment. What return are you getting on your money that you're lending out, when you factor in the default rate? Remember, these loans are not FDIC insured. Credit cards are charging these folks a minimum of 18%, and credit cards are not stupid. Make sure you're getting a huge return.

Good luck! I hope it goes well for you!

Re:credit checks?

Both sites have credit checks. Prosper lets you specified credit levels as a lender in your offers, Zopa from a quick look through the cite doesn't seem to.

It's not new, just a different slant...

... a bank, but without the legal security, This is exactly how a bank works, but in a different source. A bank can affoard to lend you money because it indemnifies those loans with invested money from other companies.

Not new, but different. Interesting

End-run around anti-discrimination statutes

Check out the loan requests at prosper.com -- lots of them include the borrower's age, ethnicity, gender, etc. either outright stated or inferable from the accompanying photographs. While Prosper as the lender of record only provides a credit grade based on an objective score from an Equifax report, the individual lenders are no doubt going to make (or not make) loans according to their own personal prejudices. The very fact that this information is available to prospective "loan buyers" (who are the actual lenders in all but name) will very quickly attract the attention of regulators.

Re:End-run around anti-discrimination statutes

If (and this is a *very big if*) this idea were actually doable, then you wouldn't have to worry about discrimination because peers who were non-discriminatory would be able to make boatloads of cash lending to clients who were not risky but being discriminated against by the marketplace. In the real world, if there are only 3 banks in your neighborhood and you need a home loan, but all 3 lending officers don't like you for whatever reason, you're sort of screwed. If, however, you have zillions of banking providers competing for your business then even if zillion - 1 say "We care more about discrimination than making a profit, neener neener" you only need one profit-maximizer to give you a loan.

In the real world, by the way, you see banks adopting the same strategy -- Bank of America invests boatloads of cash in getting its name out in the various Hispanic communities, which are typically underserved when it comes to banking services.

Re:End-run around anti-discrimination statutes

http://www.economist.com/finance/displaystory.cfm? story_id=6889252 [economist.com]

OMG!

There are already some 800 groups on Prosper ready to loan money to specific causes, such as the Apple User Group, 'a lending group for those wishing to purchase either a Macintosh or Apple iPod.'"

Yes, this is exactly the group I'd lend to -- a bunch of status-seeking wanna-be yuppies who want the cachet of conspicuously consuming an Apple product but need to borrow the money to pay for it. Uh-huh. I'm all over that.

look at numbers...

look at the numbers before you decide to invest your money into something like this... You won't be making as much money as you might think.

If $1000 loan is granted at prosper with a 10% interest rate, it'll make about $153 over three years if everyone pays up. That includes the 0.5% that prosper takes for fees and stuff. It's still lower than I expected. $1000 at 10% over 3 years, and I instantly think $300. I looked into why and it's because the principle is paid off so quickly. The $1000 number is getting smaller every month and there's not much left to earn interest by the start of the 3rd year.

If that same $1000 sits in a 3 year CD paying 4.75% (ING's current rate on a 3 year cd) it can expect to make about $149 without any of the risk associated with the prosper loans. Interest penalties might apply if it's cashed out early.

If the $1000 stays in an ING account that has 3.8% interest, you'll stand to make about $120.

I really like the idea of it, and it has the potential to make some extra $$ if you have some cash laying around not doing anything. But the Risk Factor is huge compared to the alternatives I came up with. The fact the money is still accessible at ING is worth the 33$ IMHO. Even if the money isn't needed for three years, a CD returns a few bucks less, and can still be cashed out in an emergency situation.
 

Re:look at numbers...

That's kind of an apples-and-oranges comparison. Since you get the money in your account as soon as the payments come in, unless you re-issue new loans, its equivalent to withdrawing part of the interest from a bank savings account every month and letting

Re:look at numbers...

Assuming the amount of effort in the initial investment is the same between propser and a CD, you get better returns and better security with the CD.

I dunno. Zopa, maybe, given the rates some people have quoted from their. There seems to be little on pro

Spam/Scam

I don't know how exactly because I'm not that well-versed in financial matters...but rest assured, this service WILL be spammed/scammed by the same people pushing worthless services and trying to scam you out of your hard earned money.

Clueless about what drives p2p

P2P financing is called "disintermediation" and actually has been going on in the finance world for 20+ years as borrowers approach lenders directly, rather than through banks. The commercial paper market. There are problems, mostly around collections and default. Not economically solvable for small loans.

But the very idea ignores what drives P2P: very low costs to the provider of service. Lending money is nothing of the kind -- there's a big default risk. You'd find P2P s3x to be easier!

Natural evolution of loan sharks

Seems pretty obvious this will rapidly devolve into supporting primarily folks with bad credit (or can't get loans from banks) who desparately need money FAST. Well, that and look for major identity theft rings.

Banks are highly regulated for a reason and offer strong protection to folks on both sides of the fence (investors and borrowers). New, completely unregulated financing options are really recipes for disaster and abuse - particularly in this day and age.

And, even though pieces of it will be very legitimate and well-intentioned, a few bad apples will bring down the whole scheme. Stay away (unless you want your kneecaps broken).

Re:Natural evolution of loan sharks

Seems pretty obvious this will rapidly devolve into supporting primarily folks with bad credit (or can't get loans from banks) who desparately need money FAST.

I don't see why you claim this is obvious; since there is credit rating information available t

Ok so about leechers...

I think this is great! So, how do I start leeching money from the torrents? ;)

members have to make at least £25,000

$40,000 a year ? that is huge amount of money, so you on the west actually earn this much? we earn about $3,500 a year on average, this world is wierdly unbalanced

Re:members have to make at least £25,000

As of 2003, the median income for a 4-person family in the United States was $65,093 (source [census.gov]. Median household income in the United States was $43,318 (source [census.gov]).

I'm failing to quickly find comparable figures for the UK.

GlobalGiving.com

Hey, why lend when you can give?

Global Giving [globalgiving.com] is the charitable expression of the same idea. Instead of giving at the office to some anonymous organization, why not fund: Renewable Energy to 20 Peruvian Communities [globalgiving.com], Improving Computer Literacy in Afghanistan [globalgiving.com], Information Technology for Uganda Medical Students [globalgiving.com], or whatever else floats your boat [globalgiving.com].

Re:GlobalGiving.com

Hey, why lend when you can give?

For a solution which is somewhat in-between, there's organizations which provide low-interest microfinance loans to entrepreneurs in developing countries, helping them towards econmic independence. One neat-looking organizat

can it work? Works in my home-town..

Not sure if credit unions are popular in other regions or not, but in my area (Saskatchewan, Canada) credit unions are very popular and quite successful. We have general credit unkons, teacher's credit unions, etc.

I see this as an extension of the same co

It's a great idea!

I have personally invested a hefty sum in a Nigerian financial institution run by the daughter of the country's former minister of finance. She contacted me personally (what banks can match that kind of personalized service?) and personally arranged for my account. I sent her my retirement savings and she will soon start sending me my massive returns. I will soon be rolling in obsene amounts of money!

Nigeria is the future of finance I tell you!

risk attitude

I have just got some fun logged in to Zopa as a "potential" lender. The agreed lending rate is unrealistically low. Lending to the "A" grade borrowers for 6 months gives you only 4.5% AER (annual equivalent rate) and lending to the "B" grade ones will only give you 5.0%. And you are responsible for all the tax.

I would rather lend my money to HSBC. For one of the first standard online saving
account [hsbc.co.uk], you can earn 4.75% AER (and it is not even fixed for 6 months).

The interest rate setting mechanism is kind of a double auction market. You, as either lender or borrower, can set your offer rate. The "market" rate is the one when both meeting somewhere in the middle. I mean most lenders are not really serious at this moment. They are likely to throw £10 in order to test how the system work. But, causually, you can see how people evaluate risk. For this type of unsecured loan via a potentially run-away-overnight "bank", my risk premium is way higher than 10%. Even if I trust the whole system, given a default rate of 3% quoted somewhere in their website, a risk-neutral lender will at least demand an interest rate of the "risk-less" rate (the return that you deposit in a reputable regular bank) + the default rate + their annual handling fee, which means at least 4.5+3+0.5=8%.

I'm a lender on Prosper.com

I'm in for $2500 so far and I've had very positive experience. I've already had one loan paid back in full and all but one of 29 (15 of which has had a payment due) loans has not paid. I'm getting an average 14% return.
Prosper does a lot of the credit checks for each loan. Beyond the credit score they track current lates and 90 day lates in the last 7 years on people's credit report.
If the loan does turn out to be a deadbeat the loan gets turned over to a collection agency and Prosper handles the paperwork involved to ding the person's credit.
Prosper also allows you to spread your risk by investing small amounts(no less than $50) into lots of loans.
Why should banks be the only ones getting 10-15% returns on loans.
Lenders are also starting to form informal groups (some are invitation only) where they research the borrowers and score them for the high risk high return loans.
I'm also collecting stats at http://www.savagenumber.com./ [www.savagenumber.com]

Re:Trustworthiness on the internet

Both are aiming to hit default rates of 3%, which seems low to me given that, well, this is the internet. They think they can make a real community on the internet, and are using as an analogy the way villages once functioned. Let us ignore the fact that p

Re:Adverse Selection

The fine print on those credit card offers allows the lender to change the terms for various reasons:

• you're late on a payment with a different lender
• your credit score decreases even if you've made no late payments
• you look at funny
• they just feel like it

So while prosper.com is devoid of teaser rates, I can see why someone with good credit would choose a fixed-rate, fixed-term installment loan from there over a teaser 0% offer that could become 30+% for the cost of a lost piece of mail or one two many credit pulls when shopping for a car loan.

Re:Not as good as it sounds for lenders...

What happens if there is a large-scale disaster like hurricaine Katrina? Or an economic crash? Suddenly the number of people defaulting could skyrocket.

This is no different than the risks you are exposed to in a non-insured (money market, etc.) investme

Re:Okay... right

Initially, I thought "not very", but reading through Prospers agreements (Zopa is based in the UK where my limited knowledge of law is even less applicable), I think its probably competently set up. You aren't legally lending money to the borrowers, you are agreeing to purchase loans Prosper makes, and then having Prosper continue to do the work involved in getting payment, which offloads a lot of the compliance burden, as I understand it, to them. I can't say its for-sure legal, but it passes the sniff test.

Re:Lock down your mailboxes

Because identity theft is going to SKYROCKET if this catches on.

Er, why? Its certainly no easier to scam money with identity theft from this system than traditional lenders working through the mail or the net; you might convince people to give you better

Re:This is a disaster

So I assume you never invest in stocks or corporate bonds then, because they have risk and you don't know the people you're giving money to?

There is a clear risk/reward relationship here. The highest 3 year CD rate I can find is 5.4% APY. I have $1000 in

Re:This is a disaster

Sounds like, with good credit to start with, you could snowball your way into some serious earning power.

Start with $1,000. Loan it out at 16%. Start getting monthly checks.

Take a loan for $1,000, at 8%. Loan it out at 16%. Get more monthly checks.

Re:This is a disaster

Yes, it's a good business model. It's called being a bank.