Micro finance - associated with financial empowerment in developing countries - is making a commercial comeback in the developed world. This time in the form of peer to beer banking, albeit without banks as intermediaries. Peer to peer banking uses the Internet as a virtual marketplace where lenders meet borrowers. Taking out the bank as the middle man creates both a more personal and a more competitive business model.
Taking out large, powerful and influential institutions such as a banks may seem an unconventional move at first. There is a valuable logic behind the idea, however. Proof of its success lies in the growing popularity of peer to peer financing enterprises such as Prosper.com, the British Zopa and the Dutch Boober. With relative success, they have proven that their "bankless" model has merits capable of attracting a growing community of borrowers and would-be debt speculators.
Peer to Peer financing groups attain their strength by working together with credit rating and credit collection agencies, much in the same way that traditional banks do. Would-be borrowers are registered and receive a credit score, based upon which they get a rating. This is similar to the world of corporate and institutional borrowing and lending, where the credit scores of firms and institutions are rated by agencies such as Moodies and Standard & Poor. This rating, in the same way as in the corporate world rating, gives insight to the level of risk that a loan bears.
It is important to note that, even though peer to peer financing at first glance appears rather informal, the lending contracts are in fact legally binding contracts. This means that borrowers pay by direct debit and, when borrowers miss payments, the same recovery/collection process that banks rely on are used to recover the face value of the loan.
From the perspective of a lender, the most attractive and interesting aspect of peer to peer financing is that it allows lenders to take small positions in a large number of different loans. This allows lenders to diversify risk by spreading a lending position among a large group of borrowers, while at the same time earning competitive returns.
There is a dark side to peer to peer financing, however. For the most part peer to peer financing is a by product of the consumer debt era in which we live. Credit card debt is one of the largest contributors to the disease that American consumer debt has become. Nearly 2.5 million Americans are currently in debt counseling, creating a large demand for consumer credit. Much of this demand is fueled by out of control credit card debt. Americans often own multiple credit cards and in many cases use one credit card to pay off another, creating a downward spiral of debt.
Credit card companies take advantage of the situation and earn considerable returns on high interest rate credit card debt. It is no surprise therefore that most loan or consolidation requests are instrumental in paying off expensive and out of control credit card debt. The sheer amount of refinancing actually underscores the true scope of of the cancer that has become credit card debt in America.
When investigating some of the Peer to Peer financing companies, one also sees that the level of riskiness is by no means uniform either. When correcting for U.S. and European interests rates, the American Prosper.com has much higher interest rates than the Dutch Boober.nl, suggesting that Peer to Peer financing does come with considerable risk, comparatively speaking.
For EU or other non U.S. citizens this means that the personal debt market is out of bounds, both in terms of the supply and demand of credit. This is a pity, as it is quite lucrative for European suppliers of credit to invest in American investment grade loans. For similar levels of risk, Europeans earn much lower returns.
In any case Peer to Peer finance is still very much in its infancy. The American Prosper.com, one of the largest Peer to Peer finance groups, claims to have more than 240.000 members and 49 million in loans. This would result in about 204 dollars worth of loans per member. Based on the 240.000 member base, that still amounts to a relatively low amount of loans spread among members. Nonetheless, the promise off Peer to Peer finance is one to be followed with close attention. Traditional banks would be wise to analyze what the development of Peer to Peer finance products means for their business models: is it a threat or an opportunity.
Taking out large, powerful and influential institutions such as a banks may seem an unconventional move at first. There is a valuable logic behind the idea, however. Proof of its success lies in the growing popularity of peer to peer financing enterprises such as Prosper.com, the British Zopa and the Dutch Boober. With relative success, they have proven that their "bankless" model has merits capable of attracting a growing community of borrowers and would-be debt speculators.
Peer to Peer financing groups attain their strength by working together with credit rating and credit collection agencies, much in the same way that traditional banks do. Would-be borrowers are registered and receive a credit score, based upon which they get a rating. This is similar to the world of corporate and institutional borrowing and lending, where the credit scores of firms and institutions are rated by agencies such as Moodies and Standard & Poor. This rating, in the same way as in the corporate world rating, gives insight to the level of risk that a loan bears.
It is important to note that, even though peer to peer financing at first glance appears rather informal, the lending contracts are in fact legally binding contracts. This means that borrowers pay by direct debit and, when borrowers miss payments, the same recovery/collection process that banks rely on are used to recover the face value of the loan.
From the perspective of a lender, the most attractive and interesting aspect of peer to peer financing is that it allows lenders to take small positions in a large number of different loans. This allows lenders to diversify risk by spreading a lending position among a large group of borrowers, while at the same time earning competitive returns.
There is a dark side to peer to peer financing, however. For the most part peer to peer financing is a by product of the consumer debt era in which we live. Credit card debt is one of the largest contributors to the disease that American consumer debt has become. Nearly 2.5 million Americans are currently in debt counseling, creating a large demand for consumer credit. Much of this demand is fueled by out of control credit card debt. Americans often own multiple credit cards and in many cases use one credit card to pay off another, creating a downward spiral of debt.
Credit card companies take advantage of the situation and earn considerable returns on high interest rate credit card debt. It is no surprise therefore that most loan or consolidation requests are instrumental in paying off expensive and out of control credit card debt. The sheer amount of refinancing actually underscores the true scope of of the cancer that has become credit card debt in America.
When investigating some of the Peer to Peer financing companies, one also sees that the level of riskiness is by no means uniform either. When correcting for U.S. and European interests rates, the American Prosper.com has much higher interest rates than the Dutch Boober.nl, suggesting that Peer to Peer financing does come with considerable risk, comparatively speaking.
For EU or other non U.S. citizens this means that the personal debt market is out of bounds, both in terms of the supply and demand of credit. This is a pity, as it is quite lucrative for European suppliers of credit to invest in American investment grade loans. For similar levels of risk, Europeans earn much lower returns.
In any case Peer to Peer finance is still very much in its infancy. The American Prosper.com, one of the largest Peer to Peer finance groups, claims to have more than 240.000 members and 49 million in loans. This would result in about 204 dollars worth of loans per member. Based on the 240.000 member base, that still amounts to a relatively low amount of loans spread among members. Nonetheless, the promise off Peer to Peer finance is one to be followed with close attention. Traditional banks would be wise to analyze what the development of Peer to Peer finance products means for their business models: is it a threat or an opportunity.
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