Cutting Out the Banker Middleman

In the wake of the 2008 global financial crisis, we need to rethink and redesign many organizations and institutions that have previously served us well but are now beginning to falter. Fortunately, the Internet lets us do this. It slashes collaboration costs and makes possible completely new models of combining people, skills, knowledge and capital for economic and social development. Around the world, individuals and groups are working together, developing new businesses based on peer-to-peer (P2P) collaborative networks.

The financial services industry has always been the antithesis of P2P collaboration. Hierarchy is deeply entrenched in this industry, for good reasons such as security, auditing, and regulatory compliance. But we are now seeing the rise of three types of P2P activities in this sector.

First, financial services companies are moving beyond electronic mail, document management and other primitive technologies to new collaborative software suites like Jive and Moxie Software Spaces, which encourage P2P collaboration within corporate boundaries.

Second, financial services companies themselves are beginning to act as peers, and are collaborating rather than treating one another as superiors or subordinates in the supply chain. This is good. The industry needs a new modus operandi, where all of the key players (including banks, insurers, investment brokers, rating agencies and regulators) embrace principles of transparency, integrity, collaboration and sharing of information. For example, banks should open up financial modeling and make pertinent assumptions and data transparent to all interested parties. Among other things, such P2P collaborations could enable banks to value the trillions of dollars in toxic assets that are weighing down their balance sheets.

But the third and most interesting of P2P innovations in financial services is the growing number of lenders and borrowers connecting directly via the Internet and avoiding the cost and frustration of dealing with banks altogether. The goal is to benefit both the lender and the borrower. For example, if one person is now receiving one percent interest on a savings account and another is paying 29 percent on a credit card, a mutually-agreed 10 percent rate is a match made in heaven, giving the lender a tenfold increase in return while affording the borrower a chance to begin paying down the principal. Typical P2P borrowers want to consolidate debts and pay off credit cards.

Initial attempts at Internet-enabled loan banks were a disaster. From 2005 (when P2P lending launched in the U.S.) till 2009, P2P startups experienced a boom and then went bust, culminating with regulators shutting them all down. Many investors were burned. In the case of one company,, angry investors launched a class-action lawsuit.

After the initial debacle, two of the main U.S. services, Prosper and, registered their platforms with the SEC in 2009 and 2008 respectively. Both overhauled their business models, with the stated goal of offering greater protection to the lender. They publish online their detailed financial performance figures, which are monitored by third-party sites such as

In the past two years the growth of P2P lending companies has been dramatic, with 15 percent month-over-month growth rates, and lenders receiving 8 - 10 percent returns. With these numbers, it's no surprise that some of the biggest venture capital firms, such as Union Square, Draper Fisher Jurvetson, and Google Ventures are moving into the industry.

Both Prosper and LendingClub subject would-be borrowers to rigorous scrutiny. Deadbeats are not welcome. Prosper rejects 80 percent of loan applicants; LendingClub's rejection rate is 90 percent.

According to estimates by analysis group Gartner Inc., the value of outstanding loans transacted P2P will grow to $5 billion in 2013. Although that's still a paltry amount compared to the Wall Street titans, the P2P model strikes at the core of the banking industry.

There are already more than 35 social-banking companies in more than 20 countries. Prosper in the U.S., Community Lend in Canada, Smava in Germany and Qifang in China have similar models. Today the U.K. and U.S. social-banking market has outstanding loans of $700 million.

What these P2P networks do that banks can't (or won't) is let people align their investments with individuals or causes that they believe in. Prosper accepts investments of as little as $25 and estimates its returns to be from 6 percent to 16 percent. Borrowers can post their personal stories, endorsements from friends, and group affiliations, in an effort to win the hearts, minds and dollars of potential lenders. It's easy to see why a growing number of consumers feel this is better than putting their money in a bank and watching it being gobbled away in fees.

Is this the beginning of an outright social movement? P2P lending will certainly not displace the retail lending divisions of the big banks anytime soon. That said, well-regulated social banking clearly offers many advantages, in developed markets as well as rising economies. If some of the early hurdles can be ironed out, the phenomenon has a promising future. The sheer growth of the sector has certainly chipped away at the skepticism surrounding it and reinforced the viability of a more cost-effective way for lending.

Banks should find ways to embrace these new models rather than fighting them. Experience shows that such industry disrupters can hurt those who ignore or resist them.

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