Saturday, March 18, 2006

The New Bank: spread lending emerges at Prosper

There is almost more MLMing and loan spread trading at the eBay of loans, Prosper, than regular lending. This is an example of emergence at its best, financial entrepreneurs stepping forward to create lending groups to serve as banks. Here are two examples: Example One, Example Two

Prosper competes with and potentially replaces banks and credit card companies for loans (currently) $25,000 or less and provides a credit marketplace for those below the tier of bank attractiveness and for uncollateralized loans.

Entrepreneurial lenders with high credit ratings are banding together to borrow low on Prosper and lend higher to those in lower credit tiers with poorer ratings. Just as banks have long been spread traders in the money business using their AAA-rated balance sheets to borrow at 4-5% and lend at 8-12%, entrepreneurial banking groups at Prosper are doing the same thing, squeezing the spread to a more efficient purer risk-based premium (yet theoretical risk-based premium). Prosper "banks" are currently borrowing at about 6% and lending at 8-14%, having essentially no costs except fees to Prosper and MLM fees to the bank group leader.

Are the sophisticated speculators playing both sides scaring away genuine erstwhile borrowers?

What about Risk Assessment?
It is amazing that there is so much liquidity available at Prosper. Why are these credit sob stories getting funded? Just because 120 lenders each put up $50 for a $6,000 loan does not make the loan a better idea or improve the chance of default.

Lending to a member of a group is supposed to reduce risk but this is a fallacy, group members are not in close touch and do not co-sign loans as in the micro-lending poster child Grameen Bank model, and group membership seems to be available to anyone who wants it, especially given the group leader incentive for MLM fees on group activity.

It will be very interesting to know default statistics. The risks of lending on Prosper may be substantially understated. There is no recourse. There is no collateral. There is no direct connection to the borrower. However, as junk bonds showed, lower credit tiers are often better risks, sometimes because the lending mechanism they use is their only option.

The biggest question is whether it is safer to loan to a real borrower or a new bank entrepreneur on Prosper!


Satbir said...

Can you please elaborate "lower credit tiers are often better risks.."? How?