product development

Will P2P Lending be Disruptive?

wiseclerk 3 Comments

In this – rather long – article I’ll examine if and why p2p lending has the potential to become disruptive and displace the “conventional” way banks hand out consumer loans.

A good read to get some opinions before continuing is reading these posts:

Zopa blog: ‘Why the banks need Zopa‘, which led to the post of
James Gardner,  ‘Zopa’s strategy is to be immaterial to banks‘, which was contradicted by
Chris Skinner,  ‘Why social finance and particulary Zopa matters‘, countered by
James Gardner: ‘Followup: Zopa isn’t disruptive‘

What is a disruptive innovation?

Wikipedia gives the definition that Clayton M. Christensen has coined in 1995:

Disruptive technology and disruptive innovation are terms used in business and technology literature to describe innovations that improves a product or service in ways that the market does not expect, typically by being lower priced or designed for a different set of consumers.

Disruptive innovations can be broadly classified into low-end and new-market disruptive innovations. A new-market disruptive innovation is often aimed at non-consumption (i.e., consumers who would not have used the products already on the market), whereas a lower-end disruptive innovation is aimed at mainstream customers for whom price is more important than quality.

Disruptive technologies are particularly threatening to the leaders of an existing market, because they are competition coming from an unexpected direction. …
In contrast to “disruptive innovation”, a “sustaining” innovation does not have an effect on existing markets. Sustaining innovations may be either discontinuous (i.e. “revolutionary”) or “continuous” (i.e. “evolutionary”). Revolutionary innovations are not always disruptive.

There are multiple examples in the Wikipedia article. I want to give two others here. The newspapers ignored or at least failed to adapt to what the internet meant to their classified ads business. As a result they were one of the first to loose offline business to totally new competitors (multiple ad sites, Ebay,  Craigslist and others). The music industry fought a downhill battle not to let CDs be replaced by replaced by (initially pirated) digital distribution.

In both cases the shift to the internet was inevitable, because the new technology offered a better process with superior customer experience at lower cost. The question here is if, had the dominant players faster reacted to the new medium, would they have retained (a larger part of) their dominant market position?

Cutting out the middleman?

One of the argument of p2p lending companies is that they are “cutting out the middleman”, meaning the bank out of the lending process. The way p2p lending works today, that is an argument open to attack. Continue reading →

Auxmoney Adds Audio to Borrower Profile

wiseclerk

German p2p lending service Auxmoney.com has added the option for borrowers to enhance a listing by adding an audio file. The borrower records the audio message by dialing a phone number and identifying himself by a pin supplied by Auxmoney.

Hearing the borrower describing his request creates a much more personal impression to me than only reading a text description.

To hear an audio-file created by a borrower follow this link and click on the speaker symbol (the audio is in German).

Auxmoney Screenshot June, 8th 2009; symbol for audio profile marked in red

(Source: via P2P-Kredite.com)

For Debate: A Flaw in Current P2P Lending Models?

wiseclerk 9 Comments

P2P lending holds great promise: more transparency, purposeful direction of investments and economic advantages for borrowers and lenders. Some even talk of democratization of financial processes.

But are advantages and risks evenly balanced between borrowers and lenders?

For the borrower p2p lending fulfills most promises and the only risk is that the desired loan goes unfunded. Most services have a simple fee structure with no hidden fees and the borrower only pays fees when he does receive the wanted loan. And within a time frame of a few weeks after sign-up the borrower reaches his goal – once his loan is funded and the money is transferred to his account. Platforms with auction mechanisms can even benefit the borrower further in supplying the loan at a lower interest rate then the maximum he set.

The lender on the other side is promised an attractive return on investment but faces multiple risks:

  • borrower fails to repay the loan
  • (identity) fraud
  • p2p lending company fails and ceases to service loans (e.g. Boober Netherlands)
  • unreliable forecasts of ROI and default rates
  • on some services: open/undefined tax and legal issues
  • on some microfinance services: currency exchange risks
  • on some microfinance services: risk of MFI failure

There is also an information asymmetry. The borrower usually has most of the information he needs in advance and the information he has is accurate. Should the information be not accurate (e.g. wrong information on at what interest rates he can be funded) then he can retry at no additional costs only incurring a delay. The lender has information, which is partly based on estimates or forecasts that might prove unreliable and other parts of the information might be untrue (e.g. borrower reported income or borrower description of purpose of the loan). For privacy reasons it might also be a subset of the information the p2p lending service itself has on the borrower (e.g. town of residence omitted, or income or jobs listed only in categories instead of values).

The lending experience of the lender is further hindered by the timeline. The problems may impact him at any point in time of a several year loan term. And he either has no way to terminate his investment immediately or if there is a secondary market he might be only able to do so by accepting economic disadvantages in return for the option to selling off.

The situation of the lenders in this comparison to the borrowers is worsened by the alignment of interests of the p2p lending service company with the borrowers. This is due to several factors:

  • in most models borrowers pay the larger part of the fees and are thereby important for the revenues
  • in some markets attracting borrowers is the limiting factor for growth
  • for obvious image and marketing reasons the p2p lending company is not eager to share information on fraud and (in some cases) default details
  • for the same reasons companies are slow to react and change their lender information when real default levels are much higher then fore-casted (or even advertised) default levels (examples are Prosper, MYC4)

This imparity results in different levels of satisfaction with the p2p lending service for lenders and borrowers. While those p2p lending services that offer (unmoderated) discussion forums have only few unsatisfied borrowers voicing their opinion (and then mostly on technical issues) lender concern and critic rises over time on some of these services (to the extend that Prosper even deleted it’s forum at one point in time).

Continue reading →

Peer to Peer Revolving Credit

Anders Brownworth 10 Comments

It always seemed to me that traditional banks tend to make most of their money on the backs of people that pay penalties for small errors rather than just charging for capital as their business model might otherwise suggest. Credit card companies seem to be doing the same thing, jacking rates to the maximum allowable limit if their customer goes late on a payment. All of this makes it look like the traditional banks and credit card companies are making money by being deliberately opaque, hiding their true cash cow of fees in fine print.

The peer to peer lending market has been exploiting the opportunity this opacity creates. Who would have thought these peer to peer lending sites had a chance against traditional banks? But borrowers and lenders warm up to them because they strive to become as transparent as possible.

But why do I have to get a loan for a specific need like an addition to my home? I don’t get a credit card for a particular need, its just so I have it if I need it. The reality is that the current peer to peer lending market is uncollateralized. I can’t go hold a chunk of a house ransom if a borrower doesn’t pay me back for a home improvement loan I gave him. I can’t “repo” the motorcycle I helped that guy in Utah purchase if he defaults, so what sense does it make that these are specific loans for specific goals? I’m merely making uncollateralized loans to individuals for whatever purpose they want. Its really just a bet on the person’s credit rating and “confirmed” financial situation.

So why couldn’t we think of it more like revolving credit? Why couldn’t I get a Visa or MasterCard from a P2P loan site instead? The P2P lending company would sponsor the process issuing a credit card to borrowers funded by lenders pooling their money. Adding to the existing P2P loan benefits, the lender makes more money because revolving credit interest rates are higher than “standard loans” and the borrower has much more clarity into the factors that can make his APR go down and credit limit rise over time. Continue reading →

Lending Club Introduces Self-Directed IRA to Enable Investments in P2P Lending

wiseclerk

P2P lending service Lending Club, today announced the availability of the first Self-Directed Individual Retirement Account to enable investments in peer lending. EntrustCAMA, part of the Entrust Group,  serves as the administrator for these accounts.

This new Self-Directed IRA investment choice gives individuals the ability to build a portfolio of Lending Club notes and hold that portfolio in a tax-free or tax-deferred account. To meet the Federal deadline for this tax season, applications must be completed online, printed and postmarked before April 15, 2009. The account application is available at https://www.lendingclub.com/sdIRA/registerIRA.action

Key benefits stated:

  1. Potential for high returns. Choose from a diversified group of hundreds of qualified borrowers.
  2. Tax advantages. Investments in a Self-Directed IRA can grow tax deferred until retirement age.
  3. Flexibility.
    Select the type of IRA which is right for you:
    Individuals: Traditional or Roth
    Small businesses: SIMPLE or SEP
    Fund the IRA directly with a check or an existing account (IRA or 401K) to transfer or rollover.
  4. A Diversified Retirement Portfolio. This Self-Directed IRA gives your portfolio access to Lending Club Notes, going beyond traditional stocks, bonds and mutual funds.

Fees:

  • No account opening fees
  • One flat 250 US$ annual account maintenance fee starting in 2010 when you open an account before April 15, 2009
  • No other fees
  • Low minimum starting contribution of 5,000 US$

Sources: press release, Lending Club website

P2P lending trends to expect in 2009

wiseclerk

As last year I’ll again attempt some predictions on what trends and developments can be expected in peer-to-peer lending 2009.

More competition and entering more national markets (probability 100%)
In many markets multiple p2p lending services will compete for the attention of lenders and borrowers. In other markets, where there is no national p2p lending service active yet (e.g. Canada, New Zealand), p2p lending will be introduced by the launch of a service. Possible candidates include Communitylend and Nexx.
It is hard to predict when the dormant US players (e.g. Prosper, Loanio) will overcome the regulatory hurdles and if that step is lasting.
The British market which has (compared to other markets) rather low regulatory barriers so far is dominated by a single player -  Zopa. I wonder if we’ll see the launch of a competitor there.

Boom of social lending services/p2p microfinance (probability 100%)
2008 saw the launch of Babyloan, Veecus and Wokai. Kiva funded more the 1 million US$ new loans in a single week in the end of December. The steep growth of Kiva, MyC4 and other services will continue and new p2p microfinance platforms will launch.

First Banks experiment with own p2p lending applications (probability 50%)
While p2p lending volumes are far from being a business threat to banks – banks do watch the developments. Possibly in 2009 a bank will launch its own p2p lending application. The principal aim will not be to generate revenue, but rather to collect experience and to gauge acceptance by the bank’s customers. It will be interesting to see banks testing the water on their path to implement a p2p lending concept that supplements their core business.

Continue reading →