Prosper manages credit scoring, loan servicing, and provides social and economic incentives for borrower groups to build their reputation as good lending risks. All loans are 36 months with no prepayment penalty, and Prosper charges a 1% origination fee from the borrower, and 0.5% loan servicing fee from the lender. Groups with good reputations can get some incentive payments for loan performance and lower rates over time.
In addition to using credit scoring, social lending and finance approaches can be effective and much less risky than the borrowers might otherwise appear. Informal lending clubs are common among many Asian and other immigrant communities, and something like this might provide an online venue for a more transparent and widely accessible model. It’s harder to bail out on a debt if everyone knows about it and is also a creditor.
Aside from the philosophical and community aspects, looking at this from the lender’s perspective, it looks like it would behave sort of like buying 36-month bonds with a call option. It’s not like you can do a lot of due diligence on the borrowers, and for the amounts involved it’s not going to be worth the effort, so some combination of reputation and diversification is needed. If there were lots of good-but-unrated credit risks in the borrowing pool, you could build a portfolio of sub-prime loans and possibly achieve something in the range of junk bond returns.
Returning to the philosophical, I like the idea of community and socially based lending, because it values good reputations and provides social incentives for people to perform. On the other hand, it looks like a lot of work for a prospective lender. If they’re looking purely at a financial investment, it’s a lot easier going after a portfolio of bonds or a bond fund, so I think you’d have to want to support the model to participate. The borrower’s case looks much more straightforward, since consumer credit tends to be readily available, but expensive. The listings posted on the site so far include a number of “pay off my credit card” loans, which seems quite sensible.
In a slightly different context, it would be interesting to see something similar which matched borrower groups in relatively poor and developing areas with lenders in relatively wealthy areas.Grameen Bankhas done amazing things with microfinance in Bangaladesh, in the sense of helping the borrowing communities building new businesses and opportunities for themselves and making a positive economic return for the bank.
In another different context, it would be interesting to see some kind of market making approach for investing in and financing speculative early stage startups. This wouldn’t work for capital intensive projects, but perhaps there’s some standard terms that could be worked out for asset-light software startups (aka web 2.0). The levels of funding required are too small to justify the level of effort, and there is (or should be) a high mortality rate, which would argue for a lighterweight way to build portfolios of small investments.
