Small Loans, Big Bucks: The World of Social Lending – Updated 9/29/07

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In an increasing number of countries across the world, social lending is being hailed as an alternative to ‘traditional’ bank small business and personal loans. These services connect individual lenders with individual borrowers, creating a peer-to-peer loan service that is streamlined, efficient, legally formatted, profitable, and most importantly, helpful. Social lending sites provide an opportunity for financial assistance or gain to those who would otherwise not have the opportunity.

An Overview of Services

Zopa was the first social lending site to launch, serving the United Kingdom since 2005 and now planning on extending its services to the U.S. Zopa’s basic model of lenders bidding different amounts & rates to borrowers, based on credit rating, has been adopted by the services that have followed. Zopa’s own inspiration comes from the “local micro-lending schemes that operate in Asia and Latin America. Families, neighbours or friends will lend amongst themselves, often a very structured way, to the benefit of the community. Because the groups are closely knit, trust is not usually an issue.”

Because trust is an issue in countries like the UK, social lending services do require proof of identification and some other financial disclosure. The process is still easier than receiving a loan through a bank, and lenders enjoy the high amount of transparency regarding who they’re lending to and what their money is being used for. In 2006:

“[…] three-quarters (74 per cent) of Britons said they would consider borrowing or lending through a social lending community rather than their high-street bank […] 81 per cent of lenders felt Zopa offers “significant control”, compared to only four per cent who felt that way about mainstream financial services. Zopa borrowers echoed this view, with 70 per cent of borrowers saying Zopa offered “significant control”, compared to only one per cent for mainstream banks”

Update 12/8/07: Zopa has now launched in both the United States and Italy. Unlike Prosper, a U.S. service covered below, Zopa only makes loans to borrowers of certain credit ratings, via partnerships with credit unions, but the benefit to lenders is that their loans are federally insured. CenterNetworks received an e-mail from Zopa covering this and other differences between Zopa UK and Zopa USA. I am not a CPA, but it appears to me that Zopa USA is going after the wealthy-and-cautious social lending market, while Prosper is accepting the full range of borrowers and allowing lenders to judge risk vs. return.

Prosper has emulated Zopa UK’s model, launching from the United States in 2005. Prosper has expanded on the social model of these services by creating “trusted groups”. These groups are created and led by an individual, centered around a common theme, relationship, or membership – for instance, volunteer firefighters. The presence of groups adds an extra layer of security to the service by adding social pressures to the financial ones. If a borrower doesn’t repay his loan, it reflects badly on the reputation of the entire group, thus providing incentive to the group to strongly consider each potential member, thus improving the amount of trust a lender can place in a borrower from a group with a good reputation.

Social lending is already expanding throughout Europe, in Germany via Smava and in the Netherlands via Boober. Both sites will likely attempt to expand into neighboring countries, while Zopa’s focus is on entering the U.S. market and competing with Prosper. Meanwhile, on the North American continent, CommunityLend is a social lending site that plans to serve the Canadian market, launching “and running fully by the fall of 2007”. And just last month, LendingClub launched as peer-to-peer lending for Facebook users; their service is provided through the Facebook Platform, which Prosper also has a presence on(in the form of an investment game using real Prosper listings, Fantasy Banker.).

Update 07/02/07: PPdai now services China’s social lending needs. Luyi Chen from China Web 2.0 Review has a great interview with the founder of PPdai.

For different approaches to social lending, let’s first look at CircleLending, a company that formalizes loans specifically between friends and family. Entrepreneurs typically turn to those groups first for money to get their projects started, no doubt the inspiration for this service, which since 2003 has been operating out of Boston, the second most well-known city for startups to emerge from.

The final two social lending sites we’ll look at return to the roots of microcredit, lending to the poor in developing nations. Kiva is a nonprofit service that isn’t exactly peer-to-peer lending, but instead peer-to-microfinance-institution-to-peer lending. Existing MFIs register their borrowers with Kiva, which then can be chosen by the lender to support. Money is routed through the MFIs to the borrowers, who otherwise would not have access to money from a global community.

GlobeFunder follows in the footsteps of Kiva, and aims to “create a global community of lenders”. While Kiva guarantees that 100% of a loan reaches the entrepreneur, GlobeFunder doesn’t say how much of a percentage they take from loans, if any. A blog not linked to from the GlobeFunder site, but that appears to be written by the CEO, states:

“[…] we’ve found the non-profit models in microfinance to be troublesome in many respects….it’s less about growing your business and innovation and change (and using tools to help more people) and more about protection, carving out territory, turf wars and distrust. It makes competition in for profit financial services, which has been my whole career, a piece of cake.”

Update 9/29/07: The GlobeFunder I wrote about in June appears to be relaunching, though with an apparently different model. According to their press release, GlobeFunder is targeting the U.S. market, making them a competitor to Prosper and (soon?) Zopa. They also state that by January ’08 they plan to launch in “an emerging market”, which according to a comment on this post is “Latin American and Asian countries”.

Update 12/8/07: GlobeFunder continues to promise a launch “soon”, having apparently missed their stated October 1st launch, though their most recent (November 2nd) blog entry indicates they may be in a private “soft launch” phase. They have redesigned their website, complete with annoying un-skippable flash intro.

Microloans and You

Plenty of people have written about Guy Kawasaki building Truemors, his first Web 2.0 company, for $12,107. While his site hasn’t become known as an amazing success, that has nothing to do with how much he paid to build it. One and two person startups very often start their businesses with even less than 10k, boot-strapping and scraping by until they can attract investors or become profitable. Social lending provides a means for small business to get the small amount of initial money they need the most, without having to ask friends or family, and without having to sell a permanent stake in their company. Prosper’s maximum loan amount is $25,000, and the term of Prosper loans is 3 years.

For borrowers not funding a business, social lending makes the old adage “You can’t get a loan unless you prove you don’t need one” a little less true. While you still must be able to convince others you’re able to pay them back in order to get a loan, people are much more willing to take a risk on someone they don’t know than a bank is. The only things that mean anything to a bank are how long they’ve known you, and how much they know you have. But banks aren’t in the business of risk. There’s a long line of butt-watching involved, not wanting to be the one that gets fired for giving some schmuck a major loan who never paid them back. Individuals are much more free to take a chance with their money every now and then, and the risk for each individual is reduced by being spread across multiple lenders.

Lenders are truly the people with the most opportunities on social lending sites.

  • Have a little money? Put it to good use through Kiva; knowing that you helped build a business in Africa will be much more rewarding than making $8 from a $50 investment on Prosper.
  • Have a lot of money? To me, it seems like investing in people is less risky than investing in stocks. As with both, diversify for the highest chance of good returns.
  • Have no time? I’ve seen several loan listings for money to be re-invested into Prosper, essentially people acting as investment brokers for personal loans.
  • Not a money person, but a people person? Prosper offers group leader rewards for building a group of successful, responsible borrowers.

More to Come

Social lending sites are still very young, and I say that not because I have any doubt of their success, but because I anticipate much more development as they build on that success. These services have barely scratched the surface when it comes to ‘trust’ and reputation systems. What they have now may be sufficient, but there’s potential for much more. And while it may be idealistic, I would like to think that as microlending grows, we could see a noticeable cultural impact. LendingTree and Prosper’s integration with Facebook is noteworthy because it has the potential to show college students that their money can be used for more than just their own benefit, but for the benefit of others around them as well, in a way that doesn’t conflict with the capitalist ideals American education and culture ingrain.

I’m looking forward to seeing more from this space, and I’m interested in hearing your thoughts on it.

Update 9/29/07: I’m pleased that even months after writing this entry, it continues to receive a fair amount of traffic. If you’re interested in social lending, you’d do well to check out the BarCampBank Bank & Finance Watch site, which collects information about innovations in banking and financing, and has a whole category devoted to P2P lending.

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