The following is an article scheduled to appear in the upcoming edition of The WWR Letter:
Peer-to-Peer Lending: A New Banking Alternative
By: Benjamin R. Bibler, Esquire
Peer-to-peer lending is a new banking alternative that involves average people lending money directly to borrowers in order to cut out the banking middlemen. Lenders are matched up with potential borrowers through Internet companies that derive their profits through percentage-based transaction fees. The lure to investors is the opportunity to earn above average returns on their money. The appeal to borrowers is the opportunity for people with poor or damaged credit to receive loans at a lower interest rate than available through bank loans and high-interest credit cards.
Though new sites are spawning up at a steady pace, Zopa Ltd. (“Zopa”) and Prosper Marketplace Inc. (“Prosper”) are the industry leaders. Both companies offer loans without having to deal with the expense or problems associated with having a physical structure for their clientele to visit.
Though their objectives are similar, Zopa and Prosper approach the concept of peer-to-peer lending through different means. Zopa, which is currently available in the United Kingdom and in the process of establishing operations in the U.S., examines credit ratings and personal information provided by the prospective borrower and then, in turn, offers loans at varying interest rates to those who fit a specific criteria. Prosper uses a strategy similar to eBay, which is no coincidence as Prosper is backed financially by Pierre Omidyar, the founder of eBay Inc. Prosper also examines personal information and credit ratings; however, Prosper uses this information to develop a profile of the prospective borrower that the investors can view. Prosper then puts the responsibility on the investors to make an informed decision as to whether or not they wish to loan the requested funds. Since Prosper lenders are responsible for making their own decisions, investors are encouraged to utilize “lending groups” to help police themselves in order to avoid fraud and ill-advised loans.
The fundamental approach utilized by these Internet loan companies is rather simple: charge as much interest as necessary to cover defaults and still provide an enticing rate of return for investors. Since risk is the main concern with unsecured loans, diversification is used to manage that risk. To lessen this risk, Zopa divides investors’ funds among numerous borrowers with different risk profiles to reduce the likelihood and effect of default. Prosper encourages their investors to use the same precautions. When a default does occur, the major credit bureaus are notified and collection agencies are utilized in order to seek repayment.
Some experts consider peer-to-peer lending too risky for both borrowers and lenders, especially considering the absence of Federal Deposit Insurance and regulations that normally govern the lending process. Others believe Zopa and Prosper will turn the mainstream lending industry into a more competitive and profitable business for all involved. Either way, it’s easy to imagine problems stemming from any organization that requires strangers to supply their private financial information online in order to arrange loans with one another without government protection.
Benjamin R. Bibler is an Associate in the Litigation & Defense department of the Pittsburgh office. He can be reached at (412) 338-7118 or firstname.lastname@example.org.
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