Could a Banking Revolution Start with Neighbors Lending to Each Other? Peer-to-Peer Lenders Take Banks Out of the Credit Equation

Prosper wants to shake up the banking industry, and who profits from it, by helping you borrow from and lend to your neighbors.

With demonstrators occupying Wall Street to demand financial sector reform, community-minded entrepreneurs working to take banks out of the lending equation see an opportunity: After years of obscurity and regulatory setbacks, peer-to-peer lending may be ready to step into the credit void. Where crowdfunding is the banking alternative for startups, this take on direct lending is more personal.

When Greg Dawson wanted to turn his photography hobby into a business, he knew it would require cash he didn’t have. “I was in the infancy of my marketing career in Chicago. I didn’t have the capital means to go out and buy my equipment”—a new camera, expensive lenses, a computer and editing software.

"I went to the bank first. Bank of America, where I was banking for five or six years,” Dawson says. “I was told, ‘not a chance’, because I didn’t have any assets. I didn’t own a house." He also had student loan debt, so despite a good credit score, his income to asset ratio didn’t meet BofA’s standards.

“So I took to the internet,” he says. “I think I was funded for about $4,000 in about 48 hours.” Four years later, he's the proud owner of a thriving small business. Dawson is one of several hundred thousand people who’ve gotten a loan through, a peer-to-peer lending website, and he says that the ability to put a human face on the loan was a big reason he succeeded.

“I was able to tell my story in the actual loan process,” Dawson recalls. "I was able to explain how I got into photography, how I was practicing it.” He was also able explain to prospective vendors that his debt resulted from student loans, not business failures or spending extravagance.

As banks tighten up, more and more business are turning to Prosper, the company says. That's a trend likely to continue, and one that could change how the rest of us bank too.

Show Me the Money

Browse Prosper's loan offerings, and you won’t find a seething bed of entrepreneurship. The most common category of request is for debt consolidation. Then there are home repairs, wedding expenses, and entrepreneurs like Dawson.

Prosper and its only competitor in peer-to-peer lending, LendingClub, both certify loans and place them in different risk categories with different interest rates. The lay lender doesn’t need to suss out if an unemployed homeowner should pay 8 percent or 10 percent for quick cash to plug a leaky roof. Lenders can decide what level of risk they are comfortable with while investing amounts as small as $25.

“The whole idea is to let anyone, any American, to make a loan listing on an open marketplace, and then let anyone with money, not just the oligopoly, the banks, to grant credit,” Prosper CEO Chris Larsen says. If his eBay-like marketplace for loans catches on, he predicts it will change banking—and who profits from loans.

“The spread isn’t really fair now,” he says. “Banks get to decide how much you get for savings, and how much your neighbor pays for borrowing, keeping the spread for themselves. And there’s nothing you can do about it because you aren’t allowed to lend directly to your neighbor.”

Prosper and LendingClub together have served over half a billion dollars in loans to more than 2 million members since 2007. That’s not small change, but most people don't know these sites are an option because regulations keep out many companies who would follow Prosper's lead.

What's Stopping You?

In the eyes of the Securities and Exchange Commission, you aren’t actually lending money to the smiling face you found on Prosper’s website. Instead, you are buying a product from Prosper, and that product is a security that must be registered and regulated just like any other stock or bond offering.

“That meant on a $10,000 loan to a local microbusiness, we have to go through exactly the same hurdles as a $100 million bond issuance,” Larsen says, estimating that complying with those rules cost Proper and LendingClub as much as $10 million. This has hurt the sector, with all but two of the 10 peer-to-peer lenders that existed before 2007 throwing in the towel.

Larsen argues that current regulations are a poor fit for finance in the internet age. Each time Prosper or LendingClub facilitates a loan, they must record it in the SEC’s EDGAR filing system, following the same process with a $25 loan as an investment bank does with a multimillion-dollar security. Thanks to their large volume of small loans, Prosper and LendingClub have the bizarre distinction of being among the top 10 most frequent EDGAR filers, close behind Wall Street titans like Black Rock Capital and Goldman Sachs.

While these rules pose a costly challenge, they've also spurred the innovation that is one of Prosper’s main competitive advantages: They’ve invested in the technology to process those filings as efficiently as possible.

Smart Money

Jason Lampert is a financial planner who personally invests about $4,000 through Prosper, about one-40th of his portfolio. He was looking to diversify his portfolio with an asset that “wasn’t correlated with the rest of the market," he says. "It was about looking for investments that were not controlled by Wall Street. You don’t have to pay a broker, and you don’t have to go through the stock market.”

“On an annual basis, I probably earn about 9.5 percent,” he says. “A pretty damn good return in the past couple years, and very steady.” Of nearly 160 mini-loans he’s made over the past two years, only six have fallen through, a little better than the site-wide default rate of 5.3 percent. Even that is manageable, he says, since he only invests $50 in each loan.

Lampert doesn’t scour profiles or contact borrowers to pick his investments. Instead, he has Prosper automatically assign his money in $50 increments according to risk criteria he sets each quarter.

"There’s a lot of people using the platform in a non-highly rational manner," he says. "I like the touchy-feely part, but I don’t like to make decisions based on it.”

The financial planner cautions that unlike a savings account, Prosper loans aren’t backed by FDIC insurance; if the borrower defaults, you’ll have a hard time getting your money back.

Nor can you cash out on a whim; you have to wait for loans to be paid back month-by-month. In that sense, peer-to-peer lending sites give prospective lenders both the advantages and the tradeoffs of banking: You’ll get a better interest rate, but have to manage the same loss of liquidity a bank does.

“I love the idea [of using Prosper], that’s why I decided to put my money in there,” Lampert says. “If I were going to give people investment advice, I’d say, 'only do this with money that if it were all gone, it wouldn’t kill you.'"

As Prosper and LendingClub grow, they are becoming more sophisticated at assessing risks and alleviating fraud concerns. Big venture capitalists are backing Prosper in a new round of funding, so watch for increased outreach as the site tries to build a bigger following and leverage disaffection with traditional banks.

Screenshot via (left) Wikimedia Commons (right)

Greta Thunberg has been dubbed the "Joan of Arc of climate change" for good reason. The 16-year-old activist embodies the courage and conviction of the unlikely underdog heroine, as well as the seemingly innate ability to lead a movement.

Thunberg has dedicated her young life to waking up the world to the climate crisis we face and cutting the crap that gets in the way of fixing it. Her speeches are a unique blend of calm rationality and no-holds-barred bluntness. She speaks truth to power, dispassionately and unflinchingly, and it is glorious.

Keep Reading Show less
The Planet
Ottawa Humane Society / Flickr

The Trump Administration won't be remembered for being kind to animals.

In 2018, it launched a new effort to reinstate cruel hunting practices in Alaska that had been outlawed under Obama. Hunters will be able to shoot hibernating bear cubs, murder wolf and coyote cubs while in their dens, and use dogs to hunt black bears.

Efforts to end animal cruelty by the USDA have been curtailed as well. In 2016, under the Obama Administration, the USDA issued 4,944 animal welfare citations, in two years the numbers dropped to just 1,716.

Keep Reading Show less

The disappearance of 40-year-old mortgage broker William Earl Moldt remained a mystery for 22 years because the technology used to find him hadn't been developed yet.

Moldt was reported missing on November 8, 1997. He had left a nightclub around 11 p.m. where he had been drinking. He wasn't known as a heavy drinker and witnesses at the bar said he didn't seem intoxicated when he left.

Keep Reading Show less
via Real Time with Bill Maher / YouTube and The Late Late Show with James Corden / YouTube

A controversial editorial on America's obesity epidemic and healthcare by comedian Bill Maher on his HBO show "Real Time" inspired a thoughtful, and funny, response by James Cordon. It also made for a great debate about healthcare that Americans are avoiding.

At the end of the September 6th episode of "Real Time, " Maher turned to the camera for his usual editorial and discussed how obesity is a huge part of the healthcare debate that no one is having.

"At Next Thursday's debate, one of the candidates has to say, 'The problem with our healthcare system is Americans eat shit and too much of it.' All the candidates will mention their health plans but no one will bring up the key factor: the citizens don't lift a finger to help," Maher said sternly.

Keep Reading Show less
via Gage Skidmore

The common stereotypes about liberals and conservatives are that liberals are bleeding hearts and conservatives are cold-hearted.

It makes sense, conservatives want limited government and to cut social programs that help the more vulnerable members of society. Whereas liberals don't mind paying a few more dollars in taxes to help the unfortunate.

A recent study out of Belgium scientifically supports the notion that people who scored lower on emotional ability tests tend to have right-wing and racist views.

Keep Reading Show less