Peer to Peer Lending the Rage, but Will it Last?
I keep reading with great curiosity about peer-to-peer lending programs and wondering when this, too, shall pass.
Call me skeptical. But I think it’s just not very practical nor destined to last over the long term, except as a charitable endeavor involving small sums of money going to third world countries.
What is Peer to Peer Lending?
Peer to peer lending is when one individual or business makes a loan to another business or individual. A variety of websites have cropped up to serve as matchmaking vehicles, to bring together the individual lender and individual borrower.
It’s part of the “social entrepreneurship” trend going on right now, where entrepreneurs combine making money with social goals.
The sites that facilitate peer to peer lending include Prosper.com, which focuses on loans to individuals and entrepreneurs here in the U.S., and Kiva.com, which focuses on loans to entrepreneurs in third world countries.
From the Borower’s Perspective
From a borrower’s perspective, peer to peer lending can be a godsend. If you’re an entrepreneur in Africa who needs $500 to buy some goats to start a goat milk farm, a peer to peer lending outfit like Kiva may be your only choice. And that $500 could mean the difference between your family starving or being self sufficient.
From the perspective of someone here in the U.S., the needs and impact are going to be different. This Dallas Morning News article writes about a small sporting goods business that got a $25,000 loan through Prosper.com. Apparently Prosper.com is seeing more interest from small business owners now that credit is getting tighter.
However, I don’t see peer to peer lending taking the place of credit cards, receivables factoring or traditional business loans anytime soon.
While a one-time loan through something like Prosper.com may be good, as a long-term source of funding your business operations such as factoring can become, I just don’t see it. Because it’s still a loan, whereas factoring is your money and you’re just getting the use of it much sooner.
From the Lender’s Perspective
From the perspective of the individuals who lend money to others peer-to-peer, here is where another challenge comes in. If you want to lend a small amount such as $300 to an entrepreneur in a developing country, most people will think of that as kind of charitable contribution. You probably won’t even worry too much about getting repaid. Your intention is to help out and the amount is small enough that the risk is minimal.
Contrast that with the “lenders” at something like Prosper.com, who from the Dallas Morning News story cited above are in it for investment purposes. Now, all looks rosy as long as borrowers are repaying their loans. But what if they stop paying?
The way Prosper works, a bank actually makes the loan and the “lender” buys a participating lender interest. The website suggests creating a portfolio of multiple loans in which you have a small ownership interest in each, to spread out your risk. But banking is a funny business, and high default rates can hit even the best of banks. And let’s not even talk about the fraudsters who fraudulently apply for and receive loans — even the best of banks can be the victim of fraud, too. Things can get ugly quick if you start experiencing defaults.
Loan participations are for banks that understand the risks, not individuals who may not. From my banking days when I was involved in many loan participation/loan sale transactions, I know that even banks can end up suing over a participation in a portfolio that goes bad, on the basis of insufficient underwriting, fraud, etc. I wonder how many of those individual “lenders” really are prepared for the risks, or if they will start filing lawsuits should they start losing money?
Time will tell.
