The rise of peer-to-peer lending

8th February 2012

The rise of social media, gaining more adherents than ever with Facebook's IPO making headlines, is seeing banks and financial services companies around the world harnessing the power of these collective tools.

Take the rise in social lending, for example. Peer-to-peer lending website such as Zopa may still be pulling in a tiny proportion of funds compared to high street banks, but they're not doing badly. In fact, Zopa said that January 2012 was its biggest month ever – savers lent £8.2 million to borrowers without a single banker involved.  This sum was 42% higher than Zopa's previous biggest month, when £5.8 million was lent.

Yet while social finance companies such as Zopa are prospering, P2P social lenders aren't covered by the same stringent loan obligations and rules as traditional banks, which may be why they've gone further than some established players in utilising social media.

At present, banks should promote transparency. Anthony Hilton makes pertinent observations on the opaqueness of bank trades in his Evening Standard column, and the need for transparency and direct dealings.

He writes: "The thing about investment banks' opaque trading is that a lot of it is direct with a counterparty, often another bank or insurance company, rather than on an exchange where the identity of the other side does not matter. The success of an over-the-counter investment ultimately depends on the counterparty still being around and able to fulfil its side of the bargain on the due date.

"…Most of us would be very wary about agreeing to a life-threatening operation by a surgeon who was known to have a drink problem. In trading with counterparties whose integrity they cannot guarantee investment, banks do the equivalent every day," he adds.

Fears of disintermediation among banks

Rising numbers of investors are taking matters into their own hands, disintermediating the banks and being generally mistrustful of financial authority – instead, they might go back to basics and turn to crowd-sourcing; the way things used to be done.

For example, there is the Crowdcube website, which has been the trailblazer in the UK. Businesses give a brief description, while potential investors can see how much money the group has already raised – and it then offers them the means to invest.

Perhaps new models of banking simply represent the old

Kim Stephenson, Mindful Money's resident psychologist blogger comments on how banking used to be done: "Perhaps you've gone to your friends, family or religious group, perhaps to one of the banks to raise the money.

"Of course, these type of "bankers" are the descendents of the Italian traders who would provide loans at their "banca" – a type of table. 

At the banca, you would perhaps have given a share in the venture, in return for the loan.  You would probably share the profits, if any, with your friends, family, group etc. if they put up the money.

"Someone might have insisted, or recommended that you take out insurance against the loss… 

"…So you go along to Mr. Lloyd's coffee house, where you know that a number of merchants who, rather than chance their own ventures, will effectively gamble on yours…And most of this would be done personally, among people you knew or would come to know, in the social atmosphere of a tavern, a coffee house or over a "banca" in the street."

By now the system is far more complex

It's the human ability to take something that is a good concept, overcomplicate it, make it unwieldy and expensive in the process of trying to improve it, and then have to start again, says Kim.

"You have bankers lending at different rates depending on their perception of the risk, and limited liability, and yield gaps (and then reverse yield gaps), and the more rules and ways to develop funding we wanted, the more complicated it got," he says.

"We now have stock markets, an OTC market, options, short-selling, hedges etc."

"And now we've got peer to peer and crowdfunding. We have funding appeals on social media, rather than going round to your family or religious group to get interest free loans…Basically, we're starting over again."


More from Mindful Money:

Does ‘crowdfunding' stack up for investors?

How valuable is 'Shareholder Value'?

Peer to Peer finance takes on the banks

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