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Economist.com | Articles by Subject | Person-to-person finance

THE internet age was supposed to herald hard times for the middleman. Customers, so it was said, would flock to the web to buy products and services faster, cheaper and more transparently than in shops or through intermediaries. Disintermediation has indeed come about, as any out-of-work travel agent or bookseller will tell you. Yet retail bankers�the middlemen between savers and borrowers�have been surprisingly untouched.

Enter Prosper Marketplace, a Californian company that matches people who need small loans with others who have extra cash to lend. Prosper launched its website on February 6th. This week, the number of active bids for loans was running at around 200. Lenders have put up some $750,000.

Such �person-to-person� lending is not entirely new. Zopa, a British venture that also matches borrowers with willing lenders, opened for business last March. It now boasts 50,000 members, of whom 15% are actively trying to borrow or lend money at any given time. The company does not publish the volume of loans.

On both Zopa's and Prosper's sites, borrowers, who first undergo identity and credit checks, post bids specifying how much they wish to borrow and the highest interest rate they are willing to pay. Lenders bid the lowest rate they will accept for a given credit profile (based on credit scores, debt-to-income ratios and other metrics) and period. To diversify risk, most loans are made on a �one-to-many� basis, meaning a lender's loan of, say, $5,000 would be spread across lots of borrowers. Zopa's lenders' money is strewn among at least 50 borrowers; Prosper's members can take on entire loans if they like.

The companies manage repayments and hire debt collectors should a borrower default. They make their money by charging borrowers 1% of the amount of the loan. Prosper also charges delinquency fees and levies a servicing charge on lenders. Zopa takes commissions on repayment insurance.

Zopa and Prosper say that lenders can earn a higher rate than they would from a savings account and borrowers pay less than on a credit card. According to Richard Duvall, Zopa's chief executive, interest rates on Zopa have averaged 7% before bad debts (of which there have so far been none). That compares with the 4.5% paid on a good British savings account and the 15% typically charged on credit-card debts.

There is a psychic pay-off, too. Users on Zopa have said that they like lending and borrowing within a community of �real� people, rather than through a faceless bank. Mr Duvall notes that affinity credit cards (ie, those linked to an activity or membership) tend to have lower default rates than traditional credit cards. �The sense of community matters,� he says.

Prosper takes this idea a step further, by allowing customers to form groups of borrowers with similar interests or backgrounds�similar to social networking sites such as MySpace.com or Friendster. Groups include one made up of Harvard Business School alumni, and others for atheists and agnostics. Groups with reputations for repaying loans on time can expect to get cheaper interest rates.

Chris Larsen, Prosper's founder, believes that these groups will help his company cut the two biggest costs encountered by credit-card companies: customer acquisition (often requiring pricey direct-mail or advertising campaigns) and defaults. Because group leaders earn money as their members repay loans, they have an incentive to recruit new members�in theory, doing Prosper's marketing for it. And the hope is that group members will be less prone to default because doing so would lower the credit rating of their group as a whole. Moreover, while borrowers can remain anonymous to the larger community, group leaders will know who has defaulted, so there is a �shame� factor. �It only takes lowering default rates by a fraction of a percentage point to make a difference,� says Mr Larsen.

Catherine Graeber of Forrester Research, a consultancy, is intrigued by the idea, particularly because it might attract 18- to 28-year-olds who need credit and spend hours logged on to social networking sites. These people, says Forrester, are much less likely than their parents to care about brands when choosing a bank. They are also routinely ignored by banks.

Still, potential pitfalls remain. One is that Prospect's group concept suffers from an inherent conflict: bigger groups mean more borrowers, but less cohesion, weakening the shame factor. But perhaps person-to-person finance's biggest difficulty will be to attract enough lenders�particularly once customers start to default, as they surely will. Ms Graeber points out that there is a reason why banks and credit-card companies charge the rates they do. �Unsecured lending has a high default rate,� she says. �What do these companies know that banks don't?�

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Written by Colin Henderson

March 4, 2006 at 17:22

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