Earlier today I read an interview in a Sunday paper with the former City Minister Lord Myners who criticizes the banking industry for being insufficiently competitive, even going so far as to describe it as an oligopoly, although this is probably fair comment. Lord Myners goes on to say that this lack of competition, combined with the banks’ low cost of capital, creates an inefficient market and allows the banks to make large profits easily. No doubt one solution for this is to break the banks up, but his comments got me thinking that the most efficient and effective lending system could be a widespread adoption of peer-to-peer (P2P) web financing.
What is P2P?
P2P models involve the decentralised production and distribution of goods and services over the internet involving direct consumer-to-consumer interactions, re-establishing the direct links between people that used to characterise business. With social lending, web portals would create bankless banks that would cut out the current banks as middle men.
Zopa as an example
One of P2P’s biggest successes to date is the UK based Zopa lending platform which matches lenders and borrowers at the best mutually agreed rates. Zopa achieved 170,000 users within its first two years of trading 2005 – 2007 and has since been replicated in many different countries. According to several sources on the web Zopa are able to offer the cheapest loans in the UK with no early repayment penalty and lenders can get a better financial return on their money compared to leaving it in a bank’s saving account. Apparently the default rate is only 0.05% while this risk is spread over all the site’s lenders.
In the words of Zopa on their website “both lenders and borrowers get better rates, because peer-to-peer lending is more efficient than the traditional banking model. Banks have massive overheads, with thousands of employees to pay and hundreds of branches to maintain. So they have to take large margins on the money that passes through them.” Zopa retain a certain degree of central administration in order to put a series of checks and balances in place and ensure the marketplace works smoothly. For example, Zopa give credit ratings to potential borrowers, handle repayments and also make any lenders lending more than £500 have their money spread across at least 50 borrowers.
P2P models like Zopa have effectively outsourced the relationship management element of banking to their own customers. This socialisation of finance leads an increase in influence, trust, transparency and interaction which customers are increasingly looking for and what has been lost through the impetus of banks to reduce costs via a mass market impersonal model. Social capital, experience and recommendations will become increasingly important which in turn will lead to much better service levels.
From commentary on the web it appears that the basic lending P2P model is becoming ever more sophisticated and innovative, while the same P2P principles can be (and are in the process of being) extended across financial services to eventually cover secured lending such as mortgages to savings and investments, as well as insurance services.
Simon Dixon writes a great blog on banking and monetary reform and in a recent post gives his take on whether P2P lending will replace banking. In the future Simon sees P2P becoming ever more dominant, particularly as facebook is likely to leverage its huge network to develop peer to peer lending, as well as the banks either acquiring or developing their own P2P properties. However, the P2P system will never prevail completely (and achieve a better market) until politicians reform the way the banks currently have a monopoly to supply money to the economy in the first place.
It would be great to hear what thoughts
and insights anyone else has on this subject…