Saturday, November 17, 2007


The Internet makes new inroads, this time into the credit business. Have a lookk at I think it is incredible.

Here you see how loans have recently performed.

Here is a Deutsche Bank Research paper on Web 2.0, which has a section about and similar sites at page 8.: Be a driver, not a passenger - Implications of Web 2.0 for financial institutions
Such person-to-person (P2P) lending aims to save costs by cutting out the middleman – i.e. the retail banks (see chart 7).4 Examples include Zopa in the UK, Prosper in the US, Boober in the Netherlands and most recently, Smava in Germany. Another outlet, Kiva, specialises on loans to entrepreneurs in developing countries.
Regulatory hurdles are steep but not insurmountable. Lenders are typically not allowed to lend commercially (otherwise they need a credit licence) and loans and/or investments are mostly limited to values between EUR 10,000 and EUR 35,000.5 In Germany, P2P loans are technically granted by a traditional bank which then passes these loans to the investors. As a consequence, transaction costs are higher and Smava only handles bigger allocations starting at EUR 500 (Prosper USD 50).

Lenders bear credit risk

To diversify, most loans are granted on a “one to many basis” – i.e. allocations are being spread across many loans so that the individual exposure to each loan is small. However, all models differ in detail. Zopa does not showcase individual borrowers, whereas most others let borrowers explain who they are and why they need the money. Prosper determines interest rates with an auction mechanism, others have fixed rates. Loans are typically unsecured and repayment is not guaranteed but German Smava offers a rudimentary insurance based on the default rates of a group of borrowers rather than any individual debtor. Borrowers at Prosper can improve their standing by joining (and being accepted by) a reputable group of borrowers, e.g. a group of MBA alumni. The group’s reputation depends on punctual payments being made by all members and hence there is peer pressure to conduct oneself reputably. Shame on those who do not pay on time! Kiva has a strong charity component while others are commercial.

Lenders ignore high-risk borrowers

For P2P borrowers it is easy to judge whether they are agreeing a good deal (compare the best rate offered by a bank with that of the P2P platform). For P2P lenders it is difficult because they bear the default risk and few of them are experts in risk management. Hence, the key challenge to further growth is to find more people willing to lend. Prosper, the Californian outlet which went online February 2006, has brokered loans worth around USD 70 m so far but had unfunded loan requests of more than USD 460 m. Loan requests from low-risk borrowers have the highest probability of being funded (around 45%) whereas high-risk borrowers are being ignored (less than 5% of loan bids are funded) (see chart 8).
Evidence from Prosper illustrates the difference peer-review and peer-pressure can make: default rates are typically much lower if borrowers have joined (and were accepted by) a group of borrowers – this holds in particular for high-risk and non-rated borrowers.6

Many lenders are not primarily attracted by higher interest rates but rather by the community aspect: potential borrowers explain who they are and why they need the money and lenders can actually decide which loan requests to fund and which not. A compelling story or stirring plea can make a difference. Online P2P lending also has a strong non-establishment twist (“no banks, better deals”) and many users prefer doing business with other people rather than with an impersonal bank.

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