Social Lending

In villages in India you used to have local moneylenders who were almost part of the family. They gave you money in times of need. Sometimes, they took jewellery or something else as security, but mostly they loaned you money because they knew you. Of course, it was at a profit, sometimes a huge one. Interest rates could be well over 200% :-) But, at least, you got the money when you needed it. This practice has reduced somewhat in recent years with modern day banking facilities available in most places, but I would not be surprised if it is still very common in places. That's what comes to my mind when I hear social lending. :-)

So, when I got an invitation to a Social Lending panel organized by the MIT Club of Northern California on December 5th, I was intrigued. I was curious to see how Web 2.0 had changed this age old practice :-) The panel was hosted at Wilson Sonsini Goodrich & Rosati in Palo Alto and moderated by Eric Nee, Editor of the Stanford Social Innovation Review. The panelists included John Witchel, CTO of Prosper, Patrick Gannon, SVP of Lending Club and Harvey Grasty, Head of Business Development of MicroPlace, a division of Ebay. Prosper and Lending Club have been funded by Valley VCs to the tune of $40M and $10M respectively and MicroPlace has access to a lot more funding, potentially, as part of Ebay. Prosper is the oldest of the three, having been around since early 2006, while MicroPlace launched their website in October 2007.

The concept is simple - peer to peer lending. Anyone can be a lender or a borrower. All you need is to be able to surf the web and create an account at one of the sites. The three companies have somewhat different approaches to the process, though. In all three cases, you can lend small amounts of money, as low as $25, for short periods of time, and you can choose who you will lend to. They charge a service fee of 1% in all cases. Microplace has altruistic goals of eliminating global poverty, while Prosper and Lending Club are focused more on borrowers in the United States. Microplace partners with third parties like the Calvert Foundation and others to make low interest (2-3%) loans in other countries, especially underdeveloped countries. You cannot make loans to individuals in other countries directly.

Prosper has over 500,000 registered users and $100M in loans so far, $40M in VC funding and 45 employees. They claim transparency of the process as their biggest advantage. The borrowers submit detailed information on their background and requirements and the lenders can choose who they want to lend to based on risk and return. Prosper has an automated lending process which either party can customize based on their preference. Risk is assessed based on Experian Scorex credit scores and other criteria. The borrower needs to provide a fair amount of personal info for lenders to assess, though not as much as typical banks require. The minimum credit score is 520.

Lending Club started as a peer to peer lending service for college alumni on Facebook and received $10.26 M in VC financing in August 2007. They have $3.25M in loans so far with $25M turned down. The average rate of return is 12.25% and minimum is 6.78%. The average FICO score is 692. Their users range from students to 70 or 80 year olds. The lending process is automated like Prosper. They view themselves as combining responsible credit with social networking.

All three companies claim that their process is far simpler than borrowing money from a bank, there is more transparency, a higher rate of return and the flexibility to loan money to people or causes you find interesting. They claim their default rates are low and that they assist in helping fight fraud and securing privacy. However, they have all been around a lot less than most banks, are less capitalized and are a lot smaller in people terms than the smallest of banks. If the security and privacy issues do not limit them and they grow to service a large volume of loans they have the potential to be profitable and change the banking paradigm. If, for example, you can borrow money at 7-10% to pay off $20000 in credit card bills, it looks like a win-win situation for the borrower and lender, by cutting out the middleman. As John Witchel of Prosper stated, they have many more product ideas like 5 year loans and others for the future. If they are successful in banking, there are other areas such as insurance where consumers have even less choice, which look to be possible growth areas.

I must say that these companies are fine examples of the innovative thinking that is the hallmark of Silicon Valley and the Bay Area. Whether they are successful over the longer term remains to be seen. But, the world is a better place for the attempt and surely will bring some competition to an industry which has not changed in ages, and the average consumer will benefit from it. Certainly, if the villagers in India have access to the Internet and to websites like Microplace, they will get a better deal than they could from the local moneylender, or even the local bank :-)

Madan