P2P Companies Cut Into Traditional Banking Niches


P2P companies known as peer-to-peer have cut into traditional banking niches to help finance entrepreneurs. When P2P began over a decade ago, it offered a simple way to bring borrowers and lenders together over the internet. P2P institutions such as Lending Club and Prosper allow borrowers to post businesses they want funded along with personal stories. Individuals with spare cash could invest small sums and lend in groups to the entrepreneur.

By removing banks from the loan process, borrowers received lower interest rates and funding from multiple investors. Individual lenders earned a higher rate of return than they would with a certificate of deposit. Better still borrowers who wanted to start a business had a means of making that dream a reality. Lenders seeking to help a struggling entrepreneur discovered a means of granting assistance.

Len Kendall established CentUp Industries in Chicago. He wanted a way to pair content creators and content consumers over the internet. Believing that well placed internet content can cause change, he applied for a $10,000 P2P loan in 2012. Multiple lenders pooled their funds together to make the loan possible. With an interest rate of 7.5 percent, Kendall’s loan would be repaid over three years. His lenders would receive small payments over the life of the loan.

A direct mailing campaign from Lending Club entices potential borrowers to avoid higher interest rates to banks or credit card companies. Instead, apply for a loan through Lending Club and borrow from ordinary people interested in helping the entrepreneur. Entrepreneurs feel a greater obligation to repay a loan made by individuals than institutions. Lending Club has a 0.2 default rate.

As the P2P industry matures, smaller investors no longer dominate the loan process. Large firms have begun making lending money. Lending Club and Prosper can host a plethora of new borrowers with more loans.

Lending Club estimates it has saved borrowers interest charges totaling $250 million. Both Lending Club and Prosper have issued more than $5 billion in loans with the help of larger institutions. Loans that once required days or weeks to finance are now completed in minutes making P2P institutions better able to cut into traditional banking niches and help finance entrepreneurs.

The larger institutions use algorithms to help find the better borrowers. P2P lending has raised concerns that the day will soon come when loans will become hedged and traded on secondary markets. Lending Club and Prosper now set aside a random pool of potential borrowers for the larger institutions that prefer financing an entire loan. Borrowers not taken by the larger investors are sent back to the lending pool to be divided up among institutions and smaller investors.

The policy does not sit well with P2P investors who find themselves stuck with the leftovers the larger firms rejected. Giles Andres, the chief executive of Zopa, said the cherry picking by the larger firms leaves borrowers and small lenders at greater risk.

P2P lending has developed into a game of speed. Larger institution implement allow high-speed computers to search out the best loans. Their systems are automated. Their computer servers are installed close to Lending Club and Prosper granting them microsecond advantages in finding the best borrowers.

Lending Club and Prosper now has speed limits, known as governors, to counter the larger investors. There are also purchasing limits to ensure the larger lenders do not monopolize the better borrowers. The goal is to create an improved balance among the lenders.

Many entrepreneurs lack the capital to open a business. P2P companies such as Lending Club and Prosper provide the means of bringing borrowers and lenders together. Despite large institutions attempting to monopolize the loan process by seeking the better borrowers, P2P loans have cut into niches traditionally held by banks to help entrepreneurs.

By Brian T. Yates

New York Times
The Economist

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