Peerless banking: part 2
We saw in part one that peer-to-peer banking has a lot going for it. But there are some strong negatives too.
Risky deposits - A traditional bank has FDIC insurance. And while zopa deposits may be pretty safe, there’s something disconcerting about maybe not getting your bank savings back.
Extra work - Zopa depositors need to find new loans as borrowers pay down their balances. Banks handle this job automatically, reducing the hassle factor for their depositors.
No branches - Most banking customers like branches nearby. Lots of them. To say nothing of in-network ATMs. The preference for lots of branches may be marketing presence, convenience, or some other factor. But it’s real.
No depth - No checking accounts, credit cards, mortgages, wire rooms, etc. Banks provide a lot of services beyond basic savings and personal loans. To some degree, customers appreciate having all this under one roof.
Unrealistic deposit rates
- Zopa deposits are locked for at least a year, but compared to competitive rates on demand accounts (generally lower)
- The rates account for credit losses, but not credit risk (losses will go up in bad times and this variation has a price)
- Prepayment risk is not priced in (people repay their loans quicker when rates go down - just the wrong time for lenders)
- Money repaid by borrowers sits in a lower-earning account until you find a new borrower
- Rates have been subsidized by zopa as they launch their business
Unfortunately for banks, there are technological and marketing solutions. Some will be solved perfectly - others imperfectly. But today’s flaws are not permanent.
Next: how banks should react
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Seems that this model would work best for borrowers who are pretty plain vanilla, the kind who can fit into the boxes that the big banks with fax-in-your-financials underwriting would love. Margins are already on the thin side there. But the companies that have somewhat unusual circumstances, where a real human loan officer needs to apply judgment, might find it hard to get funding at a Zopa. Just speculation on my part; I’d be interested in hearing about customers’ experiences.
Here is my beef with peer-to-peer investing in a nutshell. I looked at Prosper seriously for a while before deciding to do traditional investing instead.
1) You’ve got to diversify your loans or you’re essentially buying very expensive lottery tickets.
2) After you diversify your loans, say splitting up $1,000 in $50 chunks, there is no possible way to vet your borrowers because the time it takes to vet one in any but the most cursory manner swallows your profit from the loan.
3) #2 leads directly to people doing no vetting and just putting up standing orders for everyone meeting certain algorithmic requirements.
4) #3 the relative anonymity of the Internet = scammer’s paradise. Their results after 3 months are not encouraging, particularly in the HR category.
Prosper has an example ( http://www.prosper.com/public/lend/about_lending.aspx ) of loaning out $2000 in $100 chunks, each of them at 10%. One borrower defaults after 5 months. By Prosper’s calculation, that means you’ll make $2,222.81 after 3 years. By my calculation, you could make $2,328.51 by just parking the same money in a no-risk locked rate (5.2%) ING 3 year CD for the same term. (I have to assume that they’re not including reinvesting the repaid loans, which is slightly unfair to them. Not too much though, since you’d have to run back to your account every month and find another good prospect.)
I understand how the Internet can radically alter the banking game — drive margins to the bone, offer superior returns for depositors, make money hats for all involved. ING does it very well. I’m just missing what the economic (as opposed to personally motivating) case for the “peer to peer” element is.
Bill -
I agree 100% - zopa will never profitably market to high-touch customers on small loans. However, they may get cheaper rates in a low credit score tranche than by working with a bank that charges them appropriately for the services of a good loan officer.
That said, there still is a good niche for the old-fashioned small community banker, who knows his neighbors in ways that can’t be captured on credit reports.
Patrick -
Completely agree with your chain of logic: 1, 2, 3.
But if prosper/zopa is doing the same level of verification (and dunning welshers) as a regular credit card company, there’s no reason for fraud to accumulate at a higher rate.
Everything depends on interest rate and default rate. We need a lot more information than what the sites have posted, but it seems like these sites are hitting lower default rates than to be expected for each credit rating. If you get a high enough rate for the credit risk, you make out fine.
NB: I didn’t look closely at prosper, but I believe it works roughly like zopa.
I would love to see some of the longer-term numbers here. Is it financially viable? What sort of default rate have they seen? Where does their collection claim site in the claims priority in the case of bankruptcy, etc?
I have not applied to be a borrower, but I suspect that I would be a prime candidate to them while I drop off the radar of most banks. The joys of starting your own company. ;)
The published default rates look possibly on the low side, but it’s hard to tell - the sites need to provide some more info.
These loans would land, along with any other unsecured claims (like credit cards) right at the bottom of the pile.