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The Pluses of P2P Lending

By Marc Tracy

Our sister site Slate runs a characteristically witty and insightful take on peer-to-peer lending Websites--in which wannabe borrowers tell their stories and ask to borrow money from, well, pretty much anyone who happens upon their request and wants to fulfill it. The article's conclusion? P2P lending's supposed pluses are real, as are its supposed minuses.

The pluses over traditional lending institutions, i.e. banks, include the lack of "an extra layer of potentially corrupting bureaucracy". More importantly, the author notes, "Personal lenders may also better pick up on 'soft' characteristics of borrowers—a compelling story or convincing picture—that may be a true indication of likely repayment. Loan officers burdened by institutional rules on borrower collateral or credit history may not have the discretion to act on such information." The results of this increased reliance on "soft," or holistic, information speak for themselves: lenders (the author deals mainly with the site Prosper) have proven "quite adept at assessing the creditworthiness of prospective borrowers," the author reports, with their ability to predict credit score being far "more accurate than could be explained by accounting for the tangible financial data available."

On the other hand, this increased reliance on "soft" information can also lead to irrational lending decisions. A good, memorable example: a "massive beauty premium," under which there is a tendency to give good-looking people--prospective borrowers frequently post pictures--cheaper loans than they would otherwise deserve (in fact, interestingly enough, statistics apparently show that good-looking people are actually more likely to default!). Less amusingly, the practices of some P2P lenders have indicated a degree of racial discrimination.

Additionally, the author notes that using a P2P Website isn't exactly cutting out the middleman: there is, after all, the Website itself. The Website, of course, isn't remotely as looming a middleman as an actual bank doing the lending, however. On the other hand, those banks are insured by the federal government; as of now, P2P Websites are not.

In sum, P2P lending's great strength is its ability to exploit the "soft" financial information in order to make smarter loans, and to get credit to borrowers who may not look great on paper but who, at the end of the day, are going to pay back their debt: "This 'soft' information is particularly important for higher-risk borrowers with little financial history to guide lenders' decisions."

Higher-risk borrowers with little financial history? Sounds to us like the typical fledgling small business owner. It seems, then, like P2P definitely is a good option.

A final note we'd make. Wouldn't it be great if there were some lending mechanism that combined banks' expertise and professionalism with P2P lending's ability to take a more holistic, extensive look at prospective borrowers? Oh, right. They're called community banks.

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