Published in #nett magazine, 2008

The US sub-prime loan crisis was big news. Banks, notorious already for their profit-driven tactics, raised interest rates and refused to loan even to people with relatively solid credit ratings. Although peer-to-peer or social lending is only nascent, its long term ramifications are the same for the big banks as peer-to-peer file sharing has been for the record labels. If they don’t get in on the act themselves, they’ll fall by the wayside.

Barter meets banking

One of the biggest complaints about banks is that they charge inordinate fees and high interest rates on loans while returning pathetic rates on most investment. Peer-to-peer lending solves that. Lenders and borrowers engage in a form of haggling over interest rates. It’s a little like bidding: the borrower can select a lender with the lowest interest rate and lenders can bid as low as they’re willing to go to get someone’s custom.

The gap between bank loan and return rates is significant. Because the lenders are looking for a return that’s better than they were getting from the bank, they won’t mind bidding lower than the bank was offering for borrowers. That means everybody wins in the peer-to-peer scenario: lower rates for borrowers and higher rates for lenders. It corrects an inefficiency in banking that is perceived to stem from banker greed and has been called a “virtuous cycle”.

Peer-to-peer lending is hardly new. After all, banks themselves are fairly recent, in a grander historical sense, while lending is mentioned in the Bible (negatively, it must be admitted, but it clearly existed). Borrowing a few dollars from your mates or a larger sum from parents for a house deposit is fairly common; it only works if your mates or parents are flush with cash they don’t need themselves.

The Internet not only removes the banks from the picture, it removes the potential embarrassment of begging from people you know. The Internet can also perform another trick: it can aggregate funds and spread the risk. I might only be able to loan $25, but if 100 people can do the same, together we create a $2,500 loan. Defaulters impact in smaller ways when microfinance is in play.

Model bank

Prosper (www.prosper.com) was the first US social lending site. The UK had Zopa (uk.zopa.com), which has since expanded into the US, and hard on its heels has followed Lending Club and PeerMint, which has US, Canadian and soon Australian operations.

There are also variations on the theme: Kiva (www.kiva.org) is probably the most well-known — where most sites try to match peers (University graduates with University graduates, for example) Kiva uses peer-to-peer lending to help wealthier first-worlders finance micro-loans to entrepreneurs in third-world countries while US p2p site CircleLending —  bought out by and completely rebranded as Richard Branson’s Virgin Money (www.virginmoneyus.com/) — formalised loans between people who already knew each other rather than relying on strangers.

Branson isn’t the only one paying attention to the sector: eBay has recently bought MicroPlace (www.microplace.com), another ‘end poverty through microloans’ site.

Closer to home

Part of the reason the idea has been slow to take off here is our regulatory environment. In the US, most people have a credit rating which is a number out of 850, and it’s easily verified, for a fee. Here, the two major credit reporting bureaux, Dun & Bradstreet and Baycorp Average, keep negative credit information only — so not everyone has a rating — and there are restrictions on who they can share that with. What’s more, in Australia, applying for a loan, whether you’re successful or not, will be noted on your file.

In Australia, October 2007 saw the first peer-to-peer site to open its virtual doors: iGrin (www.igrin.com.au), a contraction of internet Group Investment Network. Phil Hopper left his position as an Executive Manager at the Commonwealth Bank of Australia to become CEO of the new financial service. With that experience behind him, he’s aware of the regulations. Technically, iGrin is the official lender on all the loans. The actual lenders — that they call funders — are buying the right to the proceeds.

iGrin uses Veda Advantage to get credit data and assigns risk ratings to the borrowers.

iGrin charges borrowers 1-2% establishment fee and charges funders 0.5-1% of the current principal as a servicing fee. iGrin has so far loaned a total of $170,000. That’s a drop in the ocean compared to the $150 billion currently outstanding in the Australian personal and credit card loan market.

iGrin offers both models for lending: the bidding model outlined above; and the ‘family and friends’ idea where you already know your lender and simply want to formalise the loan without the expense and stress of a lawyer. Direct loans like this attract lower fees too. “I think one of the attractions of the site is the personal story of it all,” says Geoff Kelly, credit and compliance officer at iGrin. “Borrowing from a bank is very internal and concealed, where social lending exposes it to a very public process.

And it’s there for anyone to participate in.” Loans are limited to $10,000.

Second off the ranks seems to be Fosik (www.fosik.com.au), a very smoothly designed site currently in beta testing which feels friendly and simple to use. Right up front, Fosik compares the rates you can get on a p2p loan (around 7.37% at the time of writing) with the big banks — NAB comes in at 12.4%, ANZ at 12.99%  and St George at 13.7%. Why would anyone go anywhere else? Like iGrin, Fosik doesn’t mind if you already know your lender or you want to borrow from their pool of generous strangers. While that service isn’t currently available to the public — launch is expected by the end of the year — documenting a loan between known parties is happening now. Fosik also distributes a DIY loan kit to newsagents but of course, online makes it all so much more straightforward. A basic loan documentation through the site will set you back a measly $19 or you can sign up for the  premium service including your very own online loan manager for $49.

CEO Pat Hammond has extensive experience as a “traditional funds manager” now turned entrepreneur. His last employer was Lichtenstein Global Trust, the bank of the Prince of Lichtenstein in the US. “There’s a lot of compliance if you’re going into a business like this,” he says. “We’ve got all that in place, APRA licensing for payments and so on. By the time [our full service] launches, we will have all the regulations for that covered too.”

Another Australian contender is PeerMint (www.peermint.com.au), the brainchild of sibling Scott, Ryan and Shelley Rigby who will head up the Australia, Canadian and New Zealand branches respectively. Scott is currently based in Brisbane working for wotif.com.au, the hotel and bookings service. Originally hoping to launch late last year, PeerMint ran into regulatory hurdles and is in the process of applying for an Australian financial services licence.

More hopefuls are LendingHub (www.lendinghub.com.au) and arbols (www.arbols.com.au) which boldly calls themselves “Australia’s first community focused social lending and borrowing site” and “Australia’s first per-to-peer finance community” respectively, even though they’re both still listed as ‘coming soon’ and iGrin has already contracted its first loan. Judging by the dates on the initial LendingHub posts (2006) it has also run into regulatory delays.

Despite the barriers to entry, peer-to-peer lending in Australia is inevitable. Prosper’s slogan is “let’s bank on each other” and in a world that’s increasingly suspicious on the one hand and increasingly trusting on the other, social and community banking seems to be the next space where the multitudes are turning away from big business and levelling the playing field themselves.

CASE STUDY
Chris is a 29-year-old high school teacher from Brisbane. He’s never met Toby, a 32-year-old archaeologist-turned-IT worker, but that doesn’t matter to either of them. Chris wanted to start a small business on the side, with a financial bent, and he needed an injection of cash — around $2,500. Toby is one of the 20 or so investors who have loaned Chris around $100–$200 each. For Toby, Chris is one of seven loans, ranging from $100 to a fair bit more, which spreads his risk. Altogether, Toby has loaned around $2000 through iGrin with rates varying from 11% per annum all the way up to 30%. He averages 14–15% which he acknowledges is “very good in today’s market”.

“Typically, I’ll only lend more than $100 to someone with an AA or a B credit rating — they’re the people who default less than half a percent of the time,” he says. “Other people I tend to look at their debt-to-income ratio. That’s really good about iGrin, because they verify the income for me. I’ve given to a couple of HRs — high risk borrowers — but it’s basically charity: if I get my money back, I get my money back. Anyone who’s an HR is giving a very high rate of return, though, so $100 is something I’m willing to risk with them.”

As for Chris, his credit rating started off as a C. He’s getting an interest rate on his loan of 11.84% which for him “isn’t spectacular” but he says part of the reason he’s in the system is to improve his credit rating. “I’m very positive about the whole process,” he says. His minimum repayments are $83.20 a month and he’s been paying back around $100 more than that each time. He’s paid back nearly half of his loan already.

Is it going to change the way people do banking? “Absolutely,” says Chris. “I think it’s a real cultural shift. When you first buy something on eBay, you’re really worried about it but now it’s just routine. iGrin goes through a lot of processes to enrol you as a client so I would expect it to be a lot more trustworthy.”

Even though they haven’t met, both men like the personal nature of the transaction. “I do like that people get the chance to borrow money for a good rate of return for something they’re passionate about,” says Toby. “And it all comes back to help me.” Eighty per cent of the time, he doesn’t really look at what the money is for, but “someone remodelling their home for a new baby or a business plan they were really passionate about” might catch his attention. From Chris’s side, the loan validates his business plan in a way that a bank loan wouldn’t. “You can’t actually just go to the bank and have someone be interested in your business. You’re reading through [the profiles] and making real value judgement on whether someone’s idea is a good idea. You know the other people who are there wanting that money as well, so people must think my idea is worthwhile.”

And it can only get better in time. According to Chris, “because it’s so young, it was quite difficult to get the whole loan. There are not enough lenders yet. There are people wanting to borrow with quite good reasons but it hasn’t hit that critical mass yet. So you get a little bit anxious waiting, hoping you’re going to get the loan through.”

“If you go to prosper.com, it’s so much more established,” says Toby. “We’re just waiting for ours to become a self-sustaining community.”