P2P Lending — The Bank And Credit Union Way

I’ve often thought that banks could easily squash P2P “lenders” like Prosper and Lending Club by creating an online lending marketplace of their own. In addition to the organic traffic they could drive to the site, they could refer loans they decide to pass on themselves, and give the option to investors/savers looking for higher rates of return than they’d get with CDs to lend money in the marketplace.

Lending Club charges a processing fee ranging from 2.25% to 4.5% of the loan amount, and hits investors with a service charge of 1% of each payment received from a borrower. Seems to me that banks could easily underprice that.

But there’s another P2P lending opportunity for banks and credit unions to capitalize on.

Do you know how much money is lent between family, friends, and acquaintances? I doubt that you do, because, as far as I know, Aite Group is the only firm to have estimated the volume of P2P transactions that occur in the US.

We’ve estimated that US consumers borrow (and presumably, repay) nearly $75 billion from each other (and not from financial institutions or other types of businesses, legal or otherwise) each year. On average, every household in the US makes two loan payments to other people for money they’ve borrowed.

That last number is actually pretty useless, since a large percentage of households don’t make any P2P transactions for the purpose of repaying loans. But in our research on consumers who use alternative financial services (e.g.,  payday loans, check cashing services, etc.), borrowing from family and friends is the second most popular source of funds (after overdrawing on their checking accounts, which might not count).

In fact, of the alternative financial services customers that Aite Group surveyed, one in four borrowed from family or friends three or more times in 2010, and more than one-third did so more often in2010 than they did in 2009.

This is a huge P2P payment opportunity for banks. Note that I didn’t say it was a P2P lending opportunity.

How are these loans and agreements documented? I have no idea, but my bet is that in many cases they’re not documented at all. After all, among friends, verbal agreement is just fine, right?

But if there was a cheap (i.e., free) and convenient way to capture the details of that loan, and a way to actually transfer the money between participants — cheaply and conveniently — don’t you think a lot of people would use it?

The money in the P2P lending space for banks isn’t from loan processing fees or from taking a cut on the interest rates. The money is in the movement of funds.

To date, banks, as a whole, have floundered with their P2P payment offerings. CashEdge and Zashpay have gained some traction, but have hardly become household names. PayPal is a household name, but the vast majority of their business isn’t P2P.

Why haven’t P2P payments taken off?

Banks are marketing it all wrong. They’re pitching the “electronic” aspect. Big deal. People don’t care about channels and methods. They simply care about what’s the most convenient thing to do when they want to do it.

Instead, banks should be marketing convenient alternatives to transacting certain types of P2P payments — repaying loans to other people being one type.

Banks could provide an online capability for the parties to document the terms of the agreement, establish repayment parameters, and enable either the automatic or manual transfer of funds. All for the low fee of a P2P transaction, and not a cut on the loan. No future disagreements about the terms of the agreement, and proof of payment.

In addition to improve the way existing customers transact P2P loans between family/friends, this approach might help attract un- and under-banked consumers who could fund an account that could either be a savings account or take the form of a prepaid card account. 

The real winner, though, will be P2P payments. By driving trial of the service, consumers may find it convenient for other use cases. 

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Led Zopalin

P2P lender Zopa has decided that wiith the leaves falling all around (here in New England, at least), it was time it was on its way. According to Zopa’s site:

While our model is doing very well in current market conditions, the US has been adversely affected in a way that just couldn’t have been predicted when we launched. So, sadly, our US colleagues have decided to withdraw from the US marketplace.”

When I read the words that it told me it made me sad, sad, sad. But on the Forum Solutions site (run by Forum CU, one of Zopa’s US partners), Doug True quotes Sarah Mason from Affinity Plus CU as saying:

As one of the credit unions who were partnered with Zopa, I would like to clarify that we have no credit availability issues and have changed none of our lending practices. This decision was made by Zopa.”

Hmmm. These would appear to be contradictory statements — but you know sometimes words have two meanings.

My take: I have to admit to being a littled dazed and confused. The “current market condition” — i.e., credit crunch — means traditional sources of funding (FI2P, or financial institution to person) is drying up. So, borrowers should be turning to alternatives sources of funds like P2P sites, no?

And with the steep drop in the stock market, investors/lenders are looking for places to put their money that will generate decent returns. So they should be turning to alternatives like P2P sites too, no? And feel even more secure about Zopa, since it’s (or was) backed by solid financial institutions, right?

In the battle for [evermore] customers, increased demand for alternative sources of funds + increased supply of funds available for alternative lending sounds like a stairway to heaven to me.

But apparently not. So what happened? I’m guessing it was a combination of:

1. The market not being ready. According to Forrester Research, consumers show “little interest [in P2P lending], mainly because they are skeptical of the benefits, are concerned about the risks, and are almost completely in the dark about firms that offer these services.”

2. The marketing not being sufficient. The flip side of factor #1 is that Zopa and its partners didn’t put enough marketing horsepower into their efforts. I remember a conversation I had in 2000 with Doug Lebda, founder of LendingTree. Although he believed that having “banks compete over you” was a better value proposition than the prevailing business model, he recognized that what he was asking consumers to change the way they went about getting a loan. And as such, he knew had to commit a lot of marketing dollars in educating consumers about this new approach and to create a new consumer brand.

3. The management team(s) not being able to focus. Management can’t disperse its attention to too many competing initiatives. So Zopa may be making a smart decision to narrow its attention and resources to the markets — namely, the UK and Italy — that promise to be the most profitable in the short term, and help fund its long term growth plans. CU contemplating starting new CUSOs should keep this in mind, too.

Bottom line: I wrote back in May that I thought Zopa had the winning business model in the P2P space. I think the key to P2P success is not through the disintermediation of financial institutions, but leveraging their risk management capabilities. I don’t think Zopa’s departure from the US is a sign that its business model was wrong.

But this should be a wake-up call to the existing players in the P2P market that their “better mousetrap” is no guarantee of success. Some marketing pundits love to say that all the rules of marketing have changed. They’re wrong. Social networks, word-of-mouth marketing, viral videos, etc. are just new ways of creating awareness, interest, and consideration among consumers. The need to manage the customer life cycle (awareness, interest, consideration, purchase) hasn’t changed — and never will.

Many dreams come true — and some have silver linings — but if P2P sites are going to gain any market share, they’ll need to spend a pocketful of gold on marketing.

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Discrimination In P2P Lending?

A couple of economics professors have published a fascinating report, that raises a lot of questions about P2P lending.

The authors analyzed all loan applications listed during a one-year period on Prosper.com. They found that listings submitted with a picture of a African-American person — or no picture at all — were significantly less likely to get funded than listings from whites with similar financial information. If funded, African-Americans were subject to a slightly higher rate.

They also discovered some discrimination against older borrowers, overweight borrowers, and borrowers that they considered to be unattractive. They did find, however, that lenders discriminated in favor of members of the military and women (especially single women).

What complicates this picture, though, is that the site’s black borrowers were more likely to default (by 36%) than the white borrowers with similar financial information. In addition, members of the military were 49% more likely than non-military borrowers to default.

My take: I’ve commented before on what I consider to be the disingenuous marketing of P2P lending sites. Prosper’s claim that it was “created to make consumer lending more financially and socially rewarding for everyone” isn’t exactly supported by the professors’ findings.

Beyond this, though, the study raises legal issues (I think — I might be wrong here. I’m not sure what the legal requirements are regarding Prosper and other P2P sites). Banks are prevented from redlining — should P2P lenders be prohibited from discriminating, as well? And if there truly is discrimination happening, what is (or should be) Prosper.com’s role in identifying it or preventing it?

Seems to me that Prosper (and possibly other P2P lending sites) runs the risk of becoming just a way for the affluent to lend to the affluent. According to the study, while borrowers with a credit grade of at least 640 accounted for just 17% all listings, they comprised 46% of all funded listings. Is this really all that different from traditional banks?

I remain somewhat skeptical that P2P sites are going to make a big dent in the banks’ lending businesses, and even more skeptical of the sites’ claims to be providing a social service.

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The Disingenuous Marketing Of P2P Lending Sites

Ponder the following question:

Entity A lends $10,000 to Johnny Jones at a rate of 6%. Entity B lends $10,000 to Johnny Jones at a rate of 6%. Which entity made the socially rewarding loan?

Well, if Entity A was Johnny’s neighbor Billy Smith, and Entity B was the bank down the street — let’s say Bank of America — then there are some who would have you believe that only Entity A made the socially rewarding contribution.

These are quotes from two P2P lending sites:

  • “Prosper…was created to make consumer lending more financially and socially rewarding for everyone.”
  • “When you lend through Fynanz you also perform a social good.”

My take: Hogwash. And that wasn’t my first choice of words.

According to Javelin Research (reported here):

Higher-income and younger consumers are the most active users (of P2P lending sites). In Javelin’s survey, 36% of borrowers said they used the service for the better interest rate. Some (33%) turned to P2P to avoid using credit cards. Others (27%) go that route because they do not qualify for a loan from a bank or credit union.”

Since when did lending to high-income consumers become a social good?

Oh, I’m sure defenders of the claims will tell that me that, surely, some borrowers at these sites are economically disadvantaged and can’t get loans at large banks and credit unions.

But let’s not forget that Prosper charges a one to three percent loan closing fee, and earns money servicing the loans for lenders. It’s not a charity.

The type of marketing that some P2P lending sites practice — playing up the social good — is an interesting and new trend. Historically, financial services marketing played on two emotions: fear and greed. The fear of losing money, and the greed of making a lot of money.

Now there’s a new tactic: Play to the desire to contribute to the overall social good. There’s nothing wrong with this — on the contrary, it’s a welcome and needed development. In fact, it might be one of the baby boomers’ biggest failures that the desire to make social contributions hasn’t been more prevalent, and more inculcated into marketing practices over the past 20 to 30 years.

But to think that P2P lending is a major contributor to this social good is naive, and for these sites to market themselves that way is disingenuous.

Javelin predicts that demand for P2P lending will quadruple over the next five years. Is it reasonable to think that the desire to lend to the economically disadvantaged will drive that growth? Or that the majority of borrowers will even be the economically disadvantaged? No, on both counts.

P2P lending sites will succeed because they’ll deliver on the greed factor, not the social contribution factor. Their ability to match people with money to invest with others who need it — and to offer those lenders (investors?) better returns than they would get otherwise will drive the growth.

Javelin also believes that the desire to pay off credit card debt will P2P lending demand. As a potential lender (investor?), I think that’s pretty risky.

But that’s exactly what the P2P lending sites should be capitalizing on. Helping potential lenders (investors?) understand how participating in P2P lending can and should be part of their portfolio of investments. Help me understand which investments in my portfolio have a similar risk/return profile as P2P loans, and could potentially be reallocated to P2P lending.

Is it lending or investing?

My questioning the substitution of the term investor for lender above is important here.

Is lending the same as investing? (For that matter is saving the same as investing? That’s something I think credit unions should be contemplating). My parents were encouraged to save. My generation was encouraged to save and invest. The notion of lending isn’t part of the language for many potential participants — i.e. suppliers — of P2P lending sites.

So while we typically think of marketing as an effort to create product demand, for P2P lending sites, marketing will be critical to procure the supply side of the equation, as well.

Relying on the desire to contribute the social good won’t be sufficient.

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