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Inside the World of Peer to Peer (p2p) Lending

Posted by admin on June 4, 2008 in Misc.

Welcome to this month’s edition of the Insiders series where I speak to the insiders behind a particular industry to get another perspective on some personal finance phenomenon or trend. In the past, I have interviewed representatives from the investment planning, hedge fund and mortgage industry.

This month I am pleased to welcome Colin Henderson, CommunityLend’s Chief Technology Officer and Dave Coleman, CommunityLend’s Community Advocate, to discuss the social lending industry. By way of explanation, social lending, as the name implies, is the lending of funds between groups of individuals rather than institutions, like banks. I took our time to speak a little about their organization, the future of p2p and some fallout from Lending Club’s decision to suspend new lenders due to regulatory issues.

CommunityLend, which is similar to Zopa UK and Prosper in the US, is a facilitator in the transaction: they are a service where lenders and borrowers, agree on a loan and, once the loan is disbursed, they administer the loan. For shorthand, I will call all of these services providers “social lending businesses” to distinguish the facilitators from the individual borrowers and lenders.

My questions are in bold and Colin and Dave’s comments in normal text. Enjoy

Colin and Dave- thanks for participating. Tell us a little about CommunityLend and your progress towards launch?

Colin: We have been watching, learning, and refining our business model and processes to best reflect what we see as the core need. We believe in changing the rules of lending, in ways that benefit all those involved in the process. In addition to your introduction we actually encourage Banks to participate.

We have been building out our infrastructure, making tweaks and adjustments, as we refine the model for launch. We will be making some announcements over the coming few days about our partners in the launch.

Besides focusing on the Canadian market-place, how is CommunityLend different than some of the others social lending companies?

Dave: We are focusing on three items that are quite different. Our first focus is on ensuring we launch a social lending platform that meets the requirements of the securities regulators in this country. We plan on creating a sustainable business, one that has long term prospects and serves the best needs of both our borrowing and lending communities. By working with the regulators, we believe we can add a necessary trust factor to this new investment model.

Secondly, we have developed a unique rating system that goes beyond the standard data available in a credit file to include other key indicators of individual financial responsibility. Our system starts with all the regular checks that a bank employee would use, but we have included other elements which will help give a more holistic representation of a borrower’s reputation. Today our rating system is good, but our focus over time will be to constantly improve OUR metrics as we learn from our marketplace.

Finally, we have structured our site around a focus on communities. Specifically, we want to help communities come together to help each other financially. Just the other day I met with the head of a craft guild. We got talking about CommunityLend and by the end of the conversation he had decided to enlist as a community leader. His goal is to help other members of his guild grow their businesses. He suggested starting a community at CommunityLend for his fellow guild members so that they can get low interest loans and purchase their own equipment instead of renting. There is currently no real role for communities to be involved in traditional lending. We think we can fix this.

Let’s talk about the business behind running a social lending businesses. When Lending Club ran into its regulatory issues, a commentator on a personal finance blog asked how social lending businesses finance all the advertising and pre-launch promotion. As far as you know, how do most social lending businesses finance themselves initially and what do the administration fees charged by social lending businesses pay for?

Colin: Like any businesses there are many ways to achieve funding. In our case we have a group of active investors who believe in the model and our management team. In terms of the fees, they go to general revenue which covers operating expenses. Our job is to ensure we keep the business model ‘flat’ and lean and replace expensive traditional processes with a smart service.

Let’s wade into issues raised by Lending Club announcing: “[We have] started a process to register, with the appropriate securities authorities, promissory notes that may be offered and sold to lenders through their site in the future. Until they complete the registration process, they will not accept new lender registrations or allow new commitments from existing lenders.” The issue arose because the original loans facilitated by Lending Club were not actually between the individual borrower and lender but the borrower and Lending Club who assign/transfer the loan to the lender (acknowledging in reality that the lender picks the borrower that Lending Club is lending to) and the loan created through the Lending Club service can be classified as a “security” and regulated by the appropriate regulators.

Colin: It is hard to comment on the Lending Club situation, simply because we are not party to their business. I can comment on the Canadian situation to some extent. The applicable regulation for our industry is the securities regulation. Broadly, the loan created between the borrower and lending on our service will be considered a security. We will therefore be regulated under securities legislation. We’ve been working with the Ontario Securities Commission for some time on the best approach for introducing social lending in Canada.

I know for legal reasons you can’t comment on Lending Club but how accurate is the rhetoric that social lending will replace the conventional banking industry if social lending businesses are basically doing everything a bank does but pick the borrower (in the interest of fairness this rhetoric has been promoted by individual users rather than the industry itself)?

Dave: We are certainly optimistic about the viability of social lending in Canada. On the one hand, you have industry analysts like Gartner stating that by 2010 social lending is going to make up 10% of all retail banking. On the other hand, you look at how conservative the average Canadian banking customer is and question whether they will part ways with their traditional institutions. We believe that there is a large group of people who are tired of the traditional ways of lending, a group of people who are looking for an organization that will really ‘change the rules of lending’ in their favor.

Rather than worry about the predictions, we will do what we can to offer a legitimate and better option for borrowers, and investors, and they will decide.

As the industry grows so will its regulation (I fully expect Consumer Protection laws to start addressing social lending as well as securities regulators creating rules specific to the industry). Do you agree with this assertion and, if so, will the regulators kill the golden goose before it is really hatched?

Colin: We see this as an iterative process. Everyone involved realises the world has changed and is changing, and the proverbial genie cannot be put back in the bottle. Having said that, the essence of regulation, including Consumer Protection, is just that, to protect consumers and we could not imagine building a business on the notion that we would do anything but protect our customers. We are confident that the approach we have proactively taken with the Canadian regulators will help to propel our business forward with confidence, and will provide for a viable long term business.

CommunityLend has the advantage of leaning from other players Globally and watching the industry unfold. Without naming names, what has the social lending industry done right and wrong initially?

Colin: again, not to speak about any future competitors, we see p2p lending / social lending at a moment in time, where web 2.0 meets reality. Almost anyone can put together a web site with a few links joining friends and networks, but to in integrate that successfully in an on-line loan auction model with robust systems and processes satisfying regulatory requirements … Now, that’s a far deeper matter…..One that we believe that we are tackling successfully

On a similar vein, what part of the branding of the p2p industry has thus far proven accurate and what part needs to change as the industry evolves?

Dave: the central brand promise of social lending is to secure lower interest loans for borrowers and to provide higher returns for lenders. The social lending model has made these results possible by making the traditional lending model more efficient; cutting out the middle man and letting borrowers and lenders connect directly. The existing companies in the space seem to be fulfilling this brand promise. Borrowers and Lenders on sites like Zopa and Prosper are able to secure better rates by working with each other directly.

What needs to evolve is the fundamental concept that social lending companies are here to replace banks. We would argue that there are plenty of opportunities for banks and social lending companies to work together. The efficiency of the social lending model in acquiring new borrowers and managing loans, especially unsecured loans, is a potential benefit for banks that traditionally have had large physical foot prints and high overhead costs. Working together instead of against each other can help banks and social lending companies extend credit to more people more efficiently. As the industry evolves I believe more social lending companies taking this approach an shifting their brand messaging.

Do you believe the industry will evolve past the facilitation and administration of loans?

Colin: we see the platform we have built as offering a host of potential services in the future which will be seen as valuable and relevant for our customers.

Without giving any specific advice, who do you think should be users of social lending sites and who are not ideal users? Everyone should use social lending is not an answer!

Dave: I would say the ideal borrower is someone who is responsible with their money, has a good credit rating, has strong community connections and a good reason for needing the loan. They probably also have a desire for a better borrowing process. We think the younger generation will really embrace borrowing using a social lending service as it is much more relaxed and laid back way of going about a process that is usually quite time consuming and stressful.

On the other side, sophisticated investors who are looking to diversify their existing portfolio in a small way might want to consider investing in consumer debt. Investors on social lending sites need to apply the same principles of investment to this new asset class called consumer debt. They need to understand the risks and the need to perform their own due diligence as well as the important benefits of diversification.

Here’s your opportunity for a shameless plug. Anything you want the readers to know?

Colin: The CommunityLend platform is designed to offer a better and more even handed approach to personal lending for all participants. We call this the democratization of lending. It is no longer the impersonal and expensive process that has traditionally existed. Soon borrowers will be able to get a better rate in a better way and sophisticated investors will be able to participate in investments in consumer debt. Our vision is to offer a platform that is valuable to all by having a strong secure infrastructure, built on a unique set of modern and compliance-oriented business processes.

Dave: Colin puts it perfectly!

We are very excited to be close to launch and are amazed by all the buzz around social lending . I would personally like to say thank you to everyone who has been supporting us as we drive towards our launch. I would especially like to thank Unspace Interactive and SIT whom we recently announced as partners. Michael Garrity, our CEO, wrote a blog post about them which can be found here.

Thanks …. it has truly been a pleasure. I cannot wait to do a follow up after we launch!