One of the results of the Global Financial Crisis was an increase in general distrust in Big Banks. Can you blame people?
Investment bankers are “supposed” to know what they are doing with your money, but they really showed their true colors by selling some shady stuff, that for the most part, they didn’t understand, or care about as long as it was making them money…
In the age of entrepreneurship (and now skepticism) that we find ourselves in today, is it possible to find an alternative to big banks when searching for a loan?
We have all been familiarized with crowdfunding over the years. Through a simple appeal to the emotions of enough people, individuals and organizations have been able to raise extraordinary amounts of money in a very short amount of time. (Here are some examples of projects funded this way.)
It didn’t take very long before companies started building themselves upon some of the principles of crowdfunding.
What Did They Make?
Peer-to-peer (P2P) lending, in some ways, has been around forever.
The basic concept is that investors are lending directly to a borrower (or borrowers) upon their own discretion and based on their own preferences and interests.
This bypasses the established financial institutions that would otherwise be used.
With our sluggish economy and low interest rates, savers and borrowers are both struggling. The P2P approach to business has been popping up everywhere and is not going away.
Bitcoin, for example, is the currency that subverts all currencies (and more importantly the governmental controls).
Because Bitcoin transactions are completely anonymous, there are no fees. This breaks free from the bureaucracy of government monetary policy and banks.
Other services such as Airbnb are creating similar business environments. Instead of being business to business transactions like P2P lending services, Airbnb connects customers to one another directly.
Uber does the same thing by connecting individual drivers to individual travelers with a relatively low amount of regulation, and the list goes on… Spotify, Skype, eBay…
The thing that all of these companies are struggling with is their relationship with government regulation. The government is scared that the market can’t hold business and customers to a high enough standard to prevent fraud and malpractice. Sustainability is a question that everyone has.
Customers, however, are pretty much on board because it gives them greater control of their own money and time.
Watch this thorough overview by corbettreport of the various critiques of centralization, as well as how P2P could be a solution to all our worries.
What’s the Problem Here?
With low interest rates and a sluggish economy, savers don’t have much incentive to save, and credit is rare and costly.
This is a paradox! How can these two things exist at one time? Why don’t the savers just lend to the borrowers at more competitive rates than the banks? Surely they would both be better off.
Well, unfortunately, there are checks in place that prevent the free flow of cash to and fro.
In the past 15 years or so, there has been a solution.
What companies such as Zopa (the first to offer P2P in the UK) offer is simply a platform where investors and borrowers can “mingle” and more easily find each other.
The company takes fees upfront known as origination fees for any loan application (although the beauty of it is that they can create any kind of business model they please), and then assigns each loan with an interest rate depending on how they asses the risk of the loan (more on that below).
Each company that provides this service gets to decide how much interest they charge. In reality, since there is nowhere near as much regulation as in the banking industry, these interest rates can be absurdly high or low…
Fortunately, market supply and demand laws ensure that a fair price for each “product”, and can in effect serve in the place of financial regulation.
The free market is a beautiful thing (Despite its limits!).
This P2P lending system is a completely natural response to the things that make the flow of money difficult. It also appeals to a new generation of people who are used to having personalized services online and on their smartphones.
The most important part (and exciting part) of P2P is the collection and analysis of customer data. If everyone who uses Uber has a smartphone (which they do), data that can improve the service is readily available.
With P2P lending, its attractiveness depends on how well the platform assesses the risks of potential borrowers. These are likely going to be computer algorithms that use data to create a profile of each customer. It’s important that interest rates are both attractive AND realistic.
The most difficult part is accessing this data without becoming like the institutions that P2P is trying to undermine. Banks already have a boat load of customer data available to them, and let me tell you, they analyze the heck out of it.
Banks though, would still love to have more data, maybe the type of data that Google has.
This is an exciting proposition because data-driven networks seem more and more to be the future.
Facebook, Google, and large institutions such as your bank have so much data available to them that they don’t know what to do with it (well actually they do for the most part).
The idea I’m getting at is that there is endless opportunity in the age of information that we are currently in. How well we use our data opens our options to tackle the problem of bureaucracy in financial markets.
This P2P lending system is a completely natural response to the things that make the flow of money difficult. If we have more power over our own data and the knowledge therein, we can rely less and less on others to manage us.
We can decide how much we think we should pay for a taxi ride, we can listen to the music that we want to instead of what the industry titans think we do, and we can participate in the loans that we feel passionate about and borrow the money that we need.
Peer-to-Peer gives us options, Peer-to-Peer gives us freedom.
I would be remiss not to mention just how dangerous this can be, but I will just say that with great reward comes great (potentially) risk.
More to come.