P2P lending marketplaces

Bye bye banks, welcome P2P lending!

P2P (Peer-to-Peer) lending is a basically a  marketplace for investing / borrowing money from others (somewhat a structure for unsecured microloans). 

Interestingly, while some services have existed for  a while (e.g., Propser), others have flourished with our now well-know world-wide financial and economic crisis (yep, I know, great business opportunity!). For example, you can read on IOUcentral that the service will be live quite soon (this is the first time I see  “Comming soon Summer 2009” on the Web 🙂 ). They are actually waiting for the registration certificate with the US Securities and Exchange Commission (SEC). Same thing for PeerMint  an equivalent service that is soon to open in Canada, Australia and New-Zealand. 

The mechanism is quite simple. In brief, on the one hand you have people who need money: for example a student who needs to pay tuitions fees, a shopping addict who has had credit card interests to pay for 2 years and wants get rid of them, an entrepreneur who has a great project that the banks won”t fund. These people build a borrower profile on a P2P lending marketplace and present their “case”. On the other hand, you have other individuals who want to invest their money (and who may be sick of giving it to the banks). They evaluate borrowers’ profiles (by the way, I think that, yes, they get access to an official credit rating), look at who they are related to, what groups they belong to (social networks!) and propose to fund part of (or the wole) amount needed by the borrower (they agree on an interest rate). Further, when the loan is agreed upon, the marketplace receives feedback regarding whether the borrower pays back in due date, and makes this information visible on the borrower’s  profile (i.e., as an objective feedback score pertaining to how good a borrower you are :-)) . This is another piece of information investors use to decide on their funding targets.

For the people interested in Research, here is the reference of an article (working paper) that has investigated the borrowing process on Prosper.com. Interestingly, the authors have found that social networks help deal with the information asymetry that exist in this marketplace (that is to say, lenders know very little about the borrowers and whether they will be pay them back). In brief, they have found that having strong and verifiable relationships (e.g., being associated with a well-know alumni network, being member of a special interest group) increases the probability of being funded (and at a lower rate!). In addition, for the money lender, identifying borrowers based on its relations leads to a lower risk of default.

Judging borrowers by the company they keep: social networks and adverse selection in online peer-to-peer lending    by Lin, M., N. Prabhala, and S. Viswanathan (March 2009)