Peer to Peer lending has emerged as a viable alternative to conventional lending by banks. It is certainly proving to be a better way of obtaining personal loans. There are valid reasons for this. Banks borrow small amounts from several account holders and lend them to parties that need finance. Since banks are responsible for such funds, they often exercise more caution than is needed. Consequently, many borrowers may not be able to meet the requirements stipulated by the bank. An example of such criteria is the credit score. Over the years, people have realized that these scores can be manipulated and there are different ways to calculate such scores. Moreover, since the financial components in personal finance keep varying from time to time, the model of credit score calculation that is valid today may not be valid a few months down the lane. Despite such drawbacks associated with credit scores, banks continue to use them.
Another problem in borrowing from bank is the quantum of loan. Below a certain amount, lending becomes non-viable for banks. This is because there are establishment costs, employee costs, due diligence costs, etc., that the bank incurs. Some of these are distributed proportionately on loans, while others are loan specific. The total of such costs have to be recovered from the deal earnings. If the earning from the transaction is not likely to fetch returns that are enough to cover such costs, then the bank chooses to forego such lending even if the borrower is reliable and has a good credit score. This lost opportunity costs the investors quite a bit. Their funds remain idle till another borrower who qualifies in all respects is found. When profits earned on all transactions are averaged for the entire year, these zero profit periods bring them down. Therefore, resultant returns to the investors in the bank are lower because of these idle periods. In peer to peer lending such losses are minimal.
This is because Peer to Peer lending is much more personal. Here, the lender knows the borrower or a group of borrowers, as the case may be. In banks, lenders or investors are represented by the bank. Therefore, they do not know the borrower in person. Internet is one of the reasons for Peer to Peer Lending’s growing popularity. The other reason is the recessionary trend, and lack of liquidity all around. In this scenario, people may need monies for different reasons such as managing their debts, paying their bills, or clearing their credit card dues. Whatever be the reason, the lender is likely to judge them based on personal risk appetite and not a uniform risk appetite. The borrower is also at liberty not to disclose the reason for him or her needing that loan.
Internet has become a big facilitator of peer to peer lending. Both borrowers and lenders can use peer to peer lending sites. There are ample peer to peer lending sites. It is, however, not essential that all peer to peer lending businesses have same business models. Some sites facilitate direct lending, while others have indirect lending mechanism built in them. Direct lending implies the lender selects the person based on his or her requirements. Unlike banks, people from different locations across the world can access the monies or lend monies in peer to peer lending system. Of course, there is credit rating to go by. But the risk is almost entirely in the lender’s court. Lender may choose to distribute the risk over several borrowers whose credit rating is similar. Indirect lending is similar to the system in banks. Almost all costs in peer to peer lending are lower, partly due to Internet. Because of this, borrowers can get finance at a cheaper rate, and lender can still earn returns that are higher than what he or she would earn by investing the monies in bank.
