The Bankwatch

Tracking the consumer evolution of financial services

“Credit crisis has given social lending a friendly pat on the back” | Economist

Brief but succint article on social lending summarises the interesting fork in the financial services road that is beginning to highlight the new model and why it has the potential to offer a legitimate alternative to traditional financial services. 

Peer-to-peer lending | Crunchless credit | Economist.com

Why aren’t social lenders raising their rates? One reason is that, unlike banks, they are not facing higher funding costs caused by the seizure in money markets. Another clue lies in that word “social”. Mr Advani, whose business is designed to facilitate loans by family and friends, points out that parents tend not to foreclose on mortgages but to restructure them. Even when strangers are involved, lenders are usually not seeking solely to maximise returns.

Most intriguing of all is the possibility that social-lending sites do a better job than their mainstream counterparts of assessing risk. Zopa, which takes a stringent approach to credit assessment and will let only prime borrowers onto the site, boasts a default rate of just 0.1%. Prosper, which is more laissez-faire and has a default rate of 3%, provides measures of “social capital”, such as endorsements by friends, that help lenders to judge the risk of a specific borrower.

Relevance to Bankwatch:
The advantages that separate peer to peer lending from traditional banking, which the article highlights are:

  1. lack of costly infrastructure:  peer to peer lenders do not have the costly infrastructure base that banks have tied up in, branches, staff, and old infrastructure based on a differently regulated model.  Banks must factor those costs into their pricing. 
  2. broader view of return:  social lenders have different expectations on return than traditional Banks.  Social lenders factor the human element into their expectations.
  3. risk assessment is better:  social lenders factor other elements into the lending decision, such as endorsements from friends or relatives.  The human scale of social lending facilitates a clear line of sight between lenders and borrowers, that is the antithesis of the Asset Backed Commercial Paper market that funds Bank lending.

The current market that peer-to-peer lending is tining compared to banking, but it is also brand new, having only begun circa 2005.  Banks would have to look to ways to insulate their own model from those disadvantages if they are to be able to compete with social lenders.

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Written by Colin Henderson

October 26, 2007 at 11:44

5 Responses

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  1. Pardon the spam, but if you’re interested in social lending you may be interested in this event:

    The MIT Club of Northern California is hosting a panel on social lending. We have panelists from Prosper, Lending Club, and Microplace. The event is in the SF bay area on Wednesday, December 5th. Here’s the event link with a more detailed description:

    http://www.mitcnc.org/Events_Single.asp?eventID=1365

    Ben Joseph

    November 30, 2007 at 00:36

  2. […] Colin presents Credit crisis has given social lending a friendly pat on the back? […]

  3. […] posted why he believes that the credit crisis has pushed peer-to-peer lending forward. He uses an article from the Economist which again quoted the 3% default rate on Prosper […]

  4. It’s rather unlikely that peer-to-peer lending will take considerable market share from the banks, but you never know. If it were to happen, I wouldn’t be surprised if the banks somehow try to get in on the trend.

    WealthBoy

    January 7, 2008 at 08:22


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