My buddy the bank

• Rosanne Bersten
• 26 September 2008
• Page 1 of 2 : single page

The US sub-prime loan crisis was big news. Banks, notorious already for their profit-driven tactics, raised interest rates and refused loans to people who had relatively solid credit ratings. Although peer-to-peer or social lending is just getting started, the long-term ramifications for the big banks are the same as peer-to-peer file sharing for the record labels: if they don’t get in on the act, they will find themselves completely bypassed.

Barter meets banking

One of the biggest complaints about banks is that they charge inordinate fees and high interest rates on loans while returning much lower rates on most investments. Peer-to-peer lending solves that.

Lenders and borrowers engage in a form of haggling over interest rates. It’s a little like bidding: the borrower can select a lender with the lowest interest rate and lenders can bid as low as they’re willing to go to get someone’s custom.

Peer-to-peer lending exploits the gap between the rate banks charge to lend you money and the rates they pay to borrow money from you – which is the basic way that banks make a profit.

Lenders are looking for a better return than they can get from putting their money in a bank, but they can still afford to charge less than a bank does for loans. That means everybody wins in the peer-to-peer scenario: lower rates for borrowers and higher rates for lenders. It corrects an inefficiency in banking that is perceived to stem from banker greed.

Peer-to-peer lending is hardly new. After all, banks themselves are fairly recent, in a grander historical sense, while lending is mentioned in the Bible (negatively, we must admit, but it clearly existed). Borrowing a few dollars from your mates or a house deposit from parents is fairly common, but it only works if your mates or parents are flush with cash they don’t need themselves.

The internet not only removes the banks from the picture, it removes the potential embarrassment of begging from people you know. The internet can also perform another trick: aggregate funds and spread the risk. I might only be able to lend $25, but if 100 people can do the same, together we create a $2,500 loan. Defaulters impact in smaller ways when microfinance is in play.

Model bank

Prosper was the first social lending site in the United States. The United Kingdom had Zopa, which has since expanded into the US, and hard on its heels followed Lending Club and PeerMint, which has US, Canadian and soon Australian operations.

There are also variations on the theme: Kiva is probably the most well known. Where most sites try to match peers – university graduates with university graduates, for example – Kiva uses peer-to-peer lending to help wealthier first-worlders finance micro-loans to entrepreneurs in third-world countries.

US peer-to-peer site CircleLending – bought out by and completely rebranded as Richard Branson’s Virgin Money – formalised loans between people who already knew each other rather than relying on strangers.
Branson isn’t the only one paying attention to the sector: eBay has recently bought MicroPlace, another ‘end poverty through micro-loans’ site.

Closer to home

One reason the idea has been slow to take off in Australia is our regulatory environment. In the US, most people have a credit rating, which is a number out of 850. It’s easily verified, for a fee. Here, the two major credit-reporting bureaus Dun & Bradstreet and Baycorp only have negative credit information, so not everyone has a rating. In addition, these agencies have restrictions on the information they are allowed to share.

In Australia, October 2007 saw the first peer-to-peer site to open its virtual doors, iGrin. Phil Hopper left his position as an executive manager at the Commonwealth Bank of Australia to become CEO of the new financial service.

With that experience behind him, he’s aware of the regulations. Technically, iGrin is the official lender on all the loans. The actual lenders, which the company calls ‘funders’, buy the rights to a share of the proceeds.
iGrin uses Veda Advantage to get credit data and assigns risk ratings to the borrowers.

iGrin charges borrowers a 1–2% establishment fee and charges funders 0.5–1% of the current principal as a servicing fee. Loans are limited to $10,000. iGrin has so far loaned a total of $170,000. That’s a drop in the ocean compared to the $150 billion Australian personal and credit card loan market.

iGrin offers both models for lending: the bidding model outlined above; and the family-and-friends idea where you already know your lender and simply want to formalise the loan without the expense and stress of a lawyer. Direct loans like this attract lower fees too.

“I think one of the attractions of the site is the personal story of it all,” says Geoff Kelly, credit and compliance officer at iGrin. “Borrowing from a bank is very internal and concealed, where social lending exposes it to a very public process. And it’s there for anyone to participate in.”

Another recent entrant into the Australian market is Fosik, a very smoothly designed site currently in beta testing.

Right up front, Fosik compares the rates you can get on a peer-to-peer loan (around 7.37% at the time of writing) with the big banks; NAB comes in at 12.4%, ANZ at 12.99% and St George at 13.7%. Why would you go anywhere else?

Like iGrin, Fosik doesn’t mind if you already know your lender or you want to borrow from its pool of generous strangers. While that service isn’t currently available to the public – launch is expected by the end of the year – documenting a loan between known parties is happening now. Fosik also distributes a do-it-yourself loan kit to newsagents but, of course, online makes it all so much more straightforward. A basic loan documentation through the site will set you back $19, or you can sign up for the premium service including your very own online loan manager for $49.

Compliance issues

Fosik CEO Pat Hammond has extensive experience as a traditional funds manager. His last employer was Lichtenstein Global Trust, the bank of the Prince of Lichtenstein in the US.

“There’s a lot of compliance if you’re going into a business like this,” he says. “We’ve got all that in place, Australian Prudential Regulation Authority licensing for payments and so on. By the time [our full service] launches, we will have all the regulations covered.”