We Bank P2P Finance Report

Report: ‘WeBank – can people replace institutions? Nesta and OpenBusiness.cc, 2009

URL = http://webank.org.uk/?p=215

(not clear whether the report below is a summary, or the report itself?)

Summary

"The report below provides background information and some analysis as part of a series of events jointly organized by Nesta and OpenBusiness.cc called ‘WeBank – can people replace institutions?’.

This report focuses on a number of emerging finance businesses that all utilize the internet to dis-intermediate traditional financial organizations and mechanisms by increasing the level of direct financial interaction of remote individuals. In other words, individuals are offered ways to act together collectively and engage in financial activities such as borrowing, lending, investing and currency exchange, without the traditional intermediary of a bank.

Both in terms of the number of businesses it covers and in the analysis it provides, this report is not exhaustive. It merely presents the start of a growing collection of business models in what has been called peer-to-peer (P2P) finance, or social or web 2.0 finance. On the internet, peer-to-peer describes a technical means of interaction in which members of a network are treated as equals, enabling fast file transfers by using and sharing computing resources collectively. In this context P2P could, of course, also stand for ‘person to person’ interaction.

It has to be noted that innovative online financial solutions have received an increasing level of attention from mainstream media, particularly in recent months. The Wall Street Journal, for example, published an article in December 2008 entitled ‘Peer Loans Ease the Credit Crunch’, and indeed they currently offer higher returns on investments than traditional banks. The Harvard Business Review, meanwhile, has included P2P finance on its list of ‘breakthrough ideas’ for 2009.

A Short History of P2P Finance

The oldest players in the P2P finance market are the UK based company Zopa and the US business Prosper. According to the P2P Banking Blog, Prosper had funded $178 million and Zopa £32 million by the end of January 2009 and had both been in business for over 4 years.

However impressive these numbers may appear given the fact that these businesses started out of nowhere just a few years ago, their turnover is still negligible when compared with traditional financial institutions. It is also noteworthy that Prosper, which provides more direct interaction between borrowers and lenders, has run into problems with the American finance regulator and is facing numerous law suits.

At the same time, Prosper and Zopa have both acted as poster-children for a small revolution. The model of ‘person-to-person-lending’ via the internet was virtually untested just 4 years ago, yet there are now well over 30 companies active in this field in countries ranging from Germany, Holland, Italy, France, Sweden and Japan.

An interesting characteristic of these businesses is that they are all focussed on one national market, mirroring the fragmentation of financial regulation (in this context) into nationally confined markets. In contrast, Kiva, a P2P lender with the mission to lend money from people in the developed world to entrepreneurs in the developing world, transfers money across national borders. So far it has funded $57.9 million worth of loans.

Whilst it is too early to draw any meaningful conclusions on whether or not the financial crisis marks an opportunity for P2P banking to grow at a faster rate and advance into the mainstream, several indicators point in this direction:

P2P finance offers higher returns

Saving accounts in banks currently provide very little return. In contrast, P2P businesses promise returns on investment of often more than 5% (ranging to more than 10%). However, these are potentially risky investments as some services offer no insurance against defaults, although Zopa and others claim to have default rates as little as 0.2%. German based P2P lender Smava recently introduced an insurance scheme making lending less risky, but increasing its costs.

P2P volumes increase

Members of the small community of entrepreneurs in the field report notable increases in uptake, however this cannot be verified as the available data is insufficient. P2P Banking Blog states that the loan growth rate for Zopa in the months November, December and January has been at £1.5 million. Also, 2008 saw new businesses open in this market at a faster rate than in any previous year.

More Experiments with P2P models

As pointed out above, the market offerings have grown from relatively small incumbents such as Zopa, Prosper and Kiva to more than 30 worldwide, varying significantly in terms of business processes. Some put borrowers and lenders into direct contact, others hold auctions and aggregate investments into bands, making the process anonymous. In addition, though philosophically related, other very different business models are being tested, such as bringing the thousands of years-old ‘rotating savings and credit associations’ (ROSCAs) online; enabling currency transfers by matching supply and demand between individuals; and focussing on confined communities such as MBA alumni lending to MBA students. And apart from companies offering new ways to borrow and lend money, we can also see innovation in areas such as collective investment into music and film production, as well as schemes to collectively ‘buy a football club’, such as MyFootballClub, which brought 50,000 people together.

It is particularly interesting to watch experiments such as Sellaband, which offers musicians a space to upload their music and distribute it for free and also engage directly with fans. Whilst, in this sense, Sellaband functions much like MySpace, it has combined this function with a distributed investment model. If an artist reaches $50,000 in investment s/he will be recorded professionally while the investors (the fans) get free CD’s and a slice of advertisement income in return. However, although more than 30 artists have reached this goal, it seems unclear if the financial return mechanism works, or if the entrepreneurs behind Sellaband have instead created an ingenious record label by minimizing their investment costs in an artist, whilst providing fans with an emotionally gratifying means of engaging with that artist.

Political awareness is increasing

While the companies examined here have generally been considered too small to appear on the radars of regulators and politicians, there are several indications that this is changing. The SEC in the US has started to investigate Prosper, while others are reportedly actively working with the national regulator.

In addition, and closer to home, in January 2009 the European Parliament called for a legislative framework to encourage micro-lending schemes. Interestingly, the EU Parliament states: ‘Microcredit – the provision of small loans to very small businesses and other borrowers who might not approach the mainstream financial system – originally emerged in the developing world, but it also has a useful role to play in stimulating grass-roots economic activity in Europe.’ Again, it is too early to say whether or not current regulatory set-ups hinder the emergence of finance mechanisms which could operate at lower costs compared to banks and also offer credit to consumers otherwise marginalized. It is also not clear whether P2P approaches represent an inherently lower risk than traditional financial institutions, or if they are just another form of the same risk, only with part of it transferred to the awareness of individuals.

Some Open Questions

It seems a question of how long before we see more successful adaptations of the above, and not whether P2P finance has a future. But it remains an open question whether or not we will see a traditional finance institution putting its marketing muscle behind a P2P finance business.

It is also not clear how well most of these business models scale. The problems surrounding US based Prosper (law suits etc) might indicate that even a system which is supposed to cut out the middleman needs strong regulation and new ethical frameworks. How much lending and borrowing that can be facilitated via the internet, whilst maintaining acceptable risk, and without an ever increasing army of humans checking credit worthiness remains to be seen. One can equally make the point that while the internet makes P2P lending possible, it does not necessarily make borrowing and lending cheaper, or safer. On the other hand new firms do often have the advantage of embracing new technologies more effectively than incumbents and are more likely to explore radically different business processes, which could result in a less costly, lower risk finance environment. We simply do not know at this point what the outcome of the above will be, but the opportunity alone makes it worthwhile to keep exploring new ways of approaching finance online, catering to people’s needs in a different way by allowing them to engage more directly with each other. As one participant of the WeBank event at Nesta noted: “Either P2P banking does not scale and is of no interest to banks, or it is the biggest threat to business that ever existed”.

Finally, one last question to consider is how much potential there is for more radical business models to be developed in the future, models which go even further, combining the characteristics of businesses such as Zopa and Prosper (lending and borrowing), with models involving collective investment. In other words, is there scope for a highly distributed ownership of a banking system?

The only thing that seems certain is that 2009 will see more innovation in online finance. In the report below, we offer an overview of these emerging businesses and encourage the reader to contact us at info at openbusiness if they have corrections and additions." (http://webank.org.uk/?p=215)