Social Lending: A New Form of Disruptive Innovation in Financial Services

What is Peer To Peer Lending All About?

‘Peer-to-peer lending is a means by which borrowers and lenders may transact business without traditional intermediaries, such as banks. The process may include other intermediaries who package and resell the loans – examples include Prosper and Zopa – but the loans are ultimately sold to individuals or pools of individuals. An enabling technology for peer-to-peer lending has been the Internet, which connects borrowers with lenders, for example through an auction-like process in which the lender willing to provide the lowest interest rate “wins” the borrowers’ loan’. Other leading models striving for foothold in Canada is Community Lend.

Social Capital and Lending is not New

‘Whereas it has been an Ancient Custom in this Kingdom for Artists to Meet together and unite themselves into Society (But more especially for those who follow any Art or Mystery) to promote Amity and true Christian Charity…’ (Rules of the Second Mechanics Society, Plymouth, 1794 as cited in Gorsky, 1998).

Friendly societies originated in Britain in the 1630s and 1640s. They were an evolution of the centuries old communal organizations of gilds and although they were similar to free masonry societies, members of friendly societies were more likely to be wage earners or artisans rather than merchants or professionals.

By the early 1700s friendly societies became better established and there were increasing trends towards institutionalisation at a local level through rules and charters and at a national level through the Friendly Societies Act of 1793, which aimed to grant various privileges in return for registration (Gorsky, 1998).

During the nineteenth century, friendly societies experienced exponential growth in membership and an increasing trend towards affiliated societies with multiple lodges. Membership in 1793 surged from 600,000 to 4 million in 1874 becoming the most well attended voluntary associations after churches (Beito, 2000).

Friendly societies membership was overwhelmingly working-class and although friendly societies did have various functions, the vast majority aimed to insure against sickness and death (Eden, 1994).

Similarly, one of the three rules of a friendly society holding meetings in a Derbyshire village pub recorded in 1736 the purpose of the society as follows:

‘And to every one that shall belong unto it after they have been in it one whole year, if sickness should come on them they shall have given unto them three shillings a week so long as it shall continue on them, and if their sickness be judged to be incurable they shall have two shillings a week while they live, and at their death shall have twenty shillings for to bury them if so required, and every member or at least those that are bidden shall convey their brother's corpse to the grave, & upon neglect of not coming, notice being given them, they shall forfeit sixpence to the box without good & just reasons be given to the Master and Wardens and they approve thereof’ (as cited in James, 2001).

Consequently, friendly societies had two main purposes – that of mutual support and financial assistance. The inseparability of these criteria is summarized by the mission statement of the Fraternal Aid Society to provide; ‘for mutual moral and material assistance’ (as cited in James, 2001).


Growth of Social Lending in Modern Times

Social Lending and a more general interest in philanthropy have in recent years seen a remarkable growth in interest. Social Lending schemes are in the process of constructing new ways of using and interacting with financial services.

According to Gartner Group, "Social banking platforms will capture 10% of the market for retail lending and financial planning. 10% of bank's revenues from retail payments will be supported by Competitors such as PayPal. Banks will shart shutting down their full-service mobile banking channels, and centralized retail core banking applications will cease to exist in at least 20 percent of banks worldwide."

Importantly, the re-emergence of Social Lending is a direct response to social trends and a demand for new forms of relationship. Because Social Lending schemes embrace the social trends that are definitional of our age, they are likely to become increasingly important in the future. Such newly emerging types of financial relationships may seriously rival more traditional mainstream financial services and prompt a need to re-examine the model of traditional banking. At the same time, these new business models provide more cost-effective options for them to reduce their risk exposure and focus on more profitable lines of business. In essence, notions of the individual within community, transparency and broader ethicality are fundamental to Social Lending schemes.

Where these are present all the “actors” in the relationship are able to act in “good faith”, where not, as is generally perceived to be the case by respondents in this research to more traditional financial services, a merely transactional relationship is developed that a significant number of people will ultimately find unsatisfying.

What is driving the need for these types of P2P lending systems are:

* Home equity used to be the cash management tool for the credit-worthy borrower, and that has really, really dried up. In many ways, Prosper's three-year, 25,000 US$ loan is a pretty good proxy for what people were using home equity for — improving their home, starting a sole proprietorship, college costs and certainly for replacing credit card debt.

* Javelin Strategy & Research is quoted that credit card debt is the main reason people want to use p2p lending. For example, research is forecasting that forecasting P2P lending specifically for credit card balances will grow from 38 billion US$ in 2007 to 159 billion US$ by 2012.


The Social Futures Observatory and Zopa released a study entitled, "Social lending the next Web 2.0 phenomenon."

This study looked at a number of Social Lending players, and used Zopa, the online marketplace where people meet to lend and borrow money, as a case study. Zopa currently has over 200,000 members in the UK. Zopa is based in the UK, while Prosper is currently the social lending leader in the U.S.

The basic idea with social lending is that when you need money, others will pool their funds together and lend them to you at x% interest rate. Prosper uses your credit score to determine your risk rate and then based on that risk rate you bid for the loan with your terms.

People who register as Prosper lenders set the minimum interest rate they are willing to earn and bid in increments of $50 to $25,000 on loan listings they select. In addition to criteria commonly used by institutional lenders, such as credit scores and histories, Prosper lenders can consider borrowers' personal stories, endorsements from friends, and group affiliations.

Borrowers create loan listings for up to $25,000 and set the maximum rate they are willing to pay a lender. Then the auction begins as Prosper lenders can bid down the interest rate. Once the auction ends, Prosper takes the bids with the lowest rates and combines them into one simple loan to the borrower. Prosper handles all on-going loan administration tasks including loan repayment and collections on behalf of the matched borrower and lenders.

What makes Zopa & Prosper popular is the "social" aspect; that is you can post your story about why you need the money. The opportunity to innovate social networking approaches into these types of lending models creates unique stickiness and there is no end of possibilities - the only limit is one's imagination.

Few of these organizations have tapped into the power of MySpace, Facebook and other major social network communities to create community ecosystem experiences... at our firm we expect more creativity to unfold in this sector in the next 12 months.

Report Highlights

On fairness and finances

* More than a third of respondents strongly agreed that the big banks aimed to put customers in debt
* 61 per cent said that the main aim of their bank was ‘to make money for themselves’
*Only 15 per cent thought that the main aim was to provide a good financial service to its customers
* 14 per cent felt their bank’s main aim was to help people manage their finances and a meagre 5 per cent thought their bank’s main aim was to provide a valuable service for society
*Between 43 and 69 per cent of people (depending on which bank they banked with – from a list of high street banks) felt that the interest rate charged on monies borrowed from high street banks was not fair in comparison to the interest rate received on savings and investments.
*Nearly 8 out of 10 people of people who have borrowed on Zopa said that Zopa secures a lower rate of interest than offered by high street banks
* On average, 64 per cent of general bankers said that they had received charges from their principle bank which they felt were unfair or unreasonable

On community, transparency and ethics

* Only 12 per cent of general bankers thought their bank was sufficiently involved in community projects, and more than 3 out of 5 claimed they were unaware their bank had community projects
* Less than 1 in 10 general bankers surveyed were aware of their mainstream bank’s endevours to enable the disadvantaged to gain access to credit, the development of community projects, environmental and entrepreneurial projects.
*The largest proportion of people, 29 per cent, claimed that they were unaware of any ethical policies

Summary Comments

Clearly we are experiencing a resurgence in these types of community driven social lending financing business models - except now we are leveraging web 2.0 or 3.0 technology and the power of social networks. This combination is very powerful and can free-form based on the wisdom of the social network crowd dynamics. The competition in this area will become fierce as companies determine what works and what does not work. Here is a brief summary of some of the players in the competitive landscape that for investors or organizations trying to understand this market need to be aware of.

1.) 1983 Grameen Bank
2.) 2005 Zopa
3.) 2005 Kiva
4.) 2005 Circle Lending - acquired by Virgin (morphed into Virgin Money)
5.) 2006 Prosper
6.) 2007 Lending Club (Face Book)
7.) 2007 Globe Funder
8.) 2008 Quizzle
9.) 2008 Nexx
10.)2008 CommunityLend
11.)2008 GreenNote
12.)2009 iGrin

Any major Retail Banking executive responsible for business strategy and innovation should be doing two key things in this area:

1.) Investing in these business models to offset market share losses; and
2.) Enabling go to market channel models to provide a way of reduced overhead costs, yet also participating in these new business models growth paths

Even smarter executives will focus on (1) and (2)as a combined business model. In terms of the Canadian landscape, if we had to bet on who will get this right first, we would put RBC and TD Capital at the top of the food chain due to their stronger Web 2.0 and Innovation cultural heritage(s).

Organizations like BNS and CIBC have not evolved their leadership talents and expertise yet sufficiently enought in Web 2.0 areas and have been either hit hard by sub debt realities or are known for not being first market movers in their respective local markets. However, what is also clear there is no winner yet in this space in the Canadian market either in the banks having access to P2P social lending Web 2.0 business models to bring to market to their customers, hence, there is tremendous opportunity in 2009-2010 for the Canadian market to pick up its innovation activities in this market.

This is a market that we will continue to watch as new forms of retail banking models like P2P social lending are new forms of disruptive innovation and the future of banking is an exciting industry to be part of.

If you have any questions, please do not hesitate to contact us at www.helixcommerce.com.