My 4 year old P2P Lending Comment, still relevant.

I came across a 4 year old comment of mine on peer-to-peer lending (before I had anything to do with it myself). And I'm surprised that I still agree with everything I said.

These lending site will only start to make sense if they can allow investors to access new areas where capital is scarce, which is hard to do in the West. (I could borrow about $23k in a few days in England, which is just frightening.) Or if they can reduce the cost of financing for both parties, which seems feasible. To do that you need better information [make a single credit more predictable] or better diversification [blend credits into a single more predictable investment].

At the moment Zopa makes diversification easy (mandatory), while Prosper gives you more data to price risk. But there's a real question of how accurate Prosper's data is. Or how safe Zopa's diversification of credit can be, given that it will be over a pool of potentially very similar borrowers.

On-line markets seem to start with a honeymoon period when most users are legitimate, then experience massive in-flows of fraud as the value transacted on them becomes worth stealing. (See .) Prosper & Zopa are likely to have to go through what Paypal/eBay did if they become successful. They're idea of Groups offers interesting ways of trying to manage this... Even if Zopa can diversify fraud risks away, the cost of dud loans would get priced into the cost of borrowing for everyone.

I think a better benchmark for evaluating these P2P lending services isn't their social value (come on - they use the same credit card networks and debt collectors as General Loan Shark Inc.), but in how they can bring the efficiencies of the money/stock/bond market to the little guy. Prosper's plans to allow lenders to sell on their debt would be a huge step forward in that. (Although perhaps not without its own legal issues.)

If I were running one of these services I'd be looking very seriously at issues like letters of credit, loans sales, collateralisation and insolvency. There's a limited amount of social capital available for stranger-to-stranger transactions. For all the rhetoric, a low-income manual worker will still have to pay a nose-bleed interest rate to start their business, unless they can mortgage something or find someone to extend a guarantee. (Besides the ability to float a callable fixed-rate bond issue against a a five year old used car would be kind'a cool !)

So my questions to both Zopa and Prosper would be:
1. How will you deal with sustained organised attempts to defraud your lenders?
2. Will you take institutional money? If not, will there be enough capital from individuals?
3. Do you intend to be more efficient than banks? If so, how? If not, then what do you offer?

I'm generally quite keen about these sorts of new lending services. But you have to make a very good case before people will start abandoning bank borrowing.