The holiday classic, “It’s a Wonderful Life” is about the magic of community, and peer-to-peer lending is now putting this magic on steroids.
In the movie, George Bailey reluctantly gives up his dreams and succeeds his late father as head of the Bailey Building & Loan. His humble governance builds community trust and provides a solid financial foundation for the town of Bedford Falls, fostering a grassroots capitalism that keeps power in the hands of the individual depositors. He doesn’t appreciate the magnitude of his achievement until he finds himself in trouble and the community rallies to support him.
The financial crisis of 2008 impaired many real-world Bedford Falls communities—many of which closely resembled Pottersville, the despotic and desperate place Bedford Falls would have become without George Bailey and his Building & Loan. Recovery hasn’t been easy, and it couldn’t happen without better access to capital.
Enter P2P lending -- the Bailey Building & Loan of the social web.
Today’s George Baileys have since founded startups like Lending Club, Funding Circle and SoFi, which are returning power to the people and enabling a whole new level of grassroots capitalism. Based on the global internet, these P2P lending platforms can connect anyone from any location, and create virtual communities of borrowers and lenders that transcend physical constraints like the geographic boundaries of a Bedford Falls.
The Opportunity for Disintermediated Lending
In the traditional financial industry we see a huge gap between borrowing rates for credit-worthy individuals and interest rates paid on savings. Narrowing this gap is the big opportunity for P2P lending.
Banks have retreated from underwriting unsecured fixed-rate loans to consumers and small businesses, pushing credit cards instead. Credit card debt has subsequently soared to more than $800 billion nationally, burdening individuals and businesses with high interest payments despite the lowest bank rates in two generations.
For economic recovery to proceed, consumers and small businesses must have access to credit at reasonable rates. Fortunately, there are people with a lot of money lying fallow in accounts paying nominal or no interest. P2P lending leverages technology to bring these two sides of the money equation together.
Borrowers pay less for the money they need, and people with money to lend get a better return on it.
Digital technologies make P2P lending simpler and more efficient, eliminating a lot of the underwriting and marketing costs incurred by traditional banks and credit card companies. These lending platforms make the loan application process more transparent, and boast faster loan turnaround times. Clear-cut eligibility requirements are published online, and customer ratings are consistently higher than those achieved by other classes of financial institutions, including credit unions and community banks.
Consequently, unsecured loans issued by P2P lending sites will triple to more than $2 billion this year, growing much faster than credit card debt and overall small business lending. As this migration to more efficient borrowing accelerates, it will have a major impact on the U.S. economy.
P2P lending’s time has come
P2P lending represents a return to the financing methods of our pre-bank history: people lending to people. Even its digital incarnation is not new by Internet standards. Why, then, is P2P lending finally poised to take off?
Consider the ingredients in the Bedford Falls example. The community rose to the occasion because (a) they became aware of the problem, and (b) they had a high level of trust gained through knowing George Bailey personally and doing business with the Building & Loan for years.
The awareness requirement is actually met much better in the digital era; information can spread from person to person much faster and more accurately than through traditional word-of-mouth methods, and isn’t limited to the environs of a Bedford Falls. Similarly, very extensive and accurate background data about borrowers is instantly available.
In contrast, trust can only be built up over years of experience, and P2P lending simply hadn’t yet achieved sufficient trust levels when it first emerged a half dozen years ago. Today, P2P lending is a proven concept with a solid track record for providing a low-volatility investment. Borrowers go through extensive screening, default rates are remarkably low, and loans are chopped into small pieces so investor risk can be spread across many of them.
Other accelerating factors include technology improvements that keep making the sites more transparent and easier to use, and an increasingly social-media-savvy customer base. And while P2P lending isn’t an outgrowth of the current economic crisis, the resulting tight-credit environment is creating an even bigger opportunity for it.
P2P lending has wings
It is fascinating to watch the basic story of the fictional 1940s Bedford Falls being replayed online today. Though communities are now virtual, members with complementary needs still engage in mutually beneficial transactions. Not charity, this grassroots capitalism is a two-way street in which individuals further strengthen their community while helping themselves.
Awareness of the new P2P financial order and the opportunities it extends to borrowers and lenders is now reaching critical mass. At the same time, trust levels have equaled or exceeded those for many traditional financial institutions.
Like George Bailey’s guardian angel Clarence Odbody, P2P lending now has wings.
Jeff joined Norwest Venture Partners in 2004 and focuses on investments in the Internet, consumer, and software arenas. He currently serves on the boards of Lending Club, Badgeville, RetailMeNot, Extole, Owler, The Echo Nest, trueXmedia and Turn. Jeff’s past investments include Admeld (acquired by Google), Jigsaw (acquired by Salesforce.com), RetailMeNot (NASDAQ: SALE), Tuvox (acquired by West Interactive), and he was a board observer at Cast Iron Systems (acquired by IBM).