The Future of Money, Part One: A pre-budget post on P2P lending's great opportunity
This is the first post in a series from ResPublica's Innovation Unit on new and innovative forms of cash, credit and equity that, in sum, might just be indicative of an entirely rewired future for our economy.
***
You've most likely seen the television programmes; heard all about the illegal money lenders with their big, big interest rates and their big, big, knuckle-dusters. These 'loan sharks' are unlicensed. They operate outside the Consumer Credit Act. They exploit some of the most vulnerable and desperate people in society, locking their customers into unaffordable loans that quickly lead to big, big debt.
The impact of the credit crunch has not only created dangerous waters for businesses and mortgages; it has created the conditions for loan sharks to multiply. According to a 2006 study conducted by the Personal Finance Research Council (PFRC) and Policis for the DTI (now BERR), at least 165,000 people used loan sharks in the UK. The New Local Government Network predicts this figure will rise to 200,000 in the coming year.
But hope springs on the horizon, in the form of the growing phenomenon of ‘Peer-to-Peer' or P2P lending.
P2P lending is, essentially, banking without banks. It allows borrowers and lenders to transact directly without financial intermediaries using the internet, more specifically, a social network style interface.
This 'sector,' fledgling though it is, offers a radical, positive alternative to illegal lending.
The P2P model was virtually untested just four years ago. There are now well over 30 companies dipping into the market. The growth of the Internet, the advancement in verification and credit scoring technology, and changing attitudes to corporate institutions have resulted in this method of lending and borrowing for everyone nearly reaching the mainstream. Additionally, an increase in individual debt, a low return on savings, and increasing asset prices are also changing consumers' borrowing and lending behaviour so as to create a favourable environment - comprising somewhat calmer waters - for these alternative investment platforms.
According to the P2P Banking Blog,
Prosper and
Zopa, two pioneers of online lending, had funded $178 million and £32 million respectively by the end of January 2009; both had
been in business for over four years. The industry as a whole was is projected to grow to $3.2 billion in 2009 and reach near $6 billion in 2010.
In topological terms, P2P is a classic
trust model, like, for example, Ebay's feedback system. P2P lending sites match individual borrowers with individual lenders. Borrowers share personal and financial information about themselves and lenders decide whether or not to contribute to their loan request. It also functions on the basis of
spread risk and horizontal resilience. Multiple individual lenders underwrite every loan, each committing a fraction of the loan until it is funded in full. Once fully funded, the loan is originated and the lenders receive their pro rata share of the principal and interest payments until the loan reaches maturity or the borrower defaults. Trust and spread risk. Two elements, you might say, of an improved, rebalanced economic model.
According to Chris Larsen, CEO of Prosper,
‘loan marketplaces undoubtedly are about money, but they're also about participation. It's the intersection of commerce and community.'
And so we might think of sites like Zopa as more like cutting-edge credit unions, resting on the simple but radical notion of mutual assistance. Consumers may not be tied by geography, as they were in the days of Victorian mutuality, and still are in the microfinance schemes of the Mo Yunus' Grameen bank. Yet the principle is the same, updated for the 21st century.
If Government has a role to play in priming this market, it could do worse than unmuddy the waters. The EU Parliament had stated that microcredit has a useful role to play in stimulating grass-roots economic activity in Europe. Labour MP and blogger Tom Watson has advocated a number of possible reforms with the aim of growing and increase attractiveness of the P2P lending market. These include removing the obligation of having to register the profit from each investment micro-investment on annual returns, in turn reducing bureaucracy and costs. We have yet to see these ideas being seriously taken up.
For any small organisation, more time and effort spent by management on legal compliance takes away from improving and innovating company structure. In an environment like this, the companies most likely to succeeded are big, old banks with strict credit rules and lending structures not the small, internet-based organisations.
Regulation is both the cure but also has the potential to cause rupture. The recent financial crisis has led, understandably, to an ever changing and expanding regulatory regime, which has hindered efforts to bring about more variety and flexibility to the credit market. We need to get that regulation right. The worst case scenario is that we do the work of the sharks for them, kill off the nascent P2P market, and 'cut off our
nodes to spite our own faces.'
With Budget Day imminent, the economy
the issue at this election, and a phantom recession menacing in the deep, radical economic solutions that simultaneously improve lives must come to the fore. Modern day credit unions, at whose vanguard is the P2P movement, are critical to the provision of carefully assessed sub-prime lending and are the key in helping to eradicate disreputable shark-like practices. They need continuous commitment from the treasury to create a positive market place for their flourishing. If successfully done, they could be a loan shark killer - and an economic winner.