This new person-to-person model of lending uses the Web to disrupt the financial services industry by directly linking people and groups who have cash to invest with people and even small businesses who want to borrow money. Consumers are able to lend and borrow money at more competitive interest rates than they could get from the banks and without the excessive charges and fees.
Few industries are as overdue a radical change as the banking sector. Banks have positioned themselves as middlemen between people who have money to invest and those who need to borrow money, earning plump margins and fat fees for the privilege. The amount of inefficiency and complexity in this market makes it as ripe for disintermediation through the Internet as travel agents and insurance brokers.
The market started to see the rise of the first major social lending marketplaces in Europe and the US around five or six years ago and, since then, they have grown from tiny operations into a major force in the global financial services industry. Gartner predicts that peer-to-peer lending will account for 10% of all outstanding consumer personal loans by end 2013.
In the US, peer-to-peer loans have eclipsed more than $1 billion since 2006 and social loan volumes calculated by the two largest players in the US are around $50 million a month and growing, according to a report by TechCrunch. In the last 30 days, these two lending marketplaces issued 5600 new loans totalling nearly $64 million, with a borrower average interest rate of 15.81%.
Institutional investors are now putting money into platforms such as Lending Club and Prosper. With banking execs such as John Mack, former CEO of Morgan Stanley, joining social lending platform Lending Club, the industry is rapidly gaining credibility in North America. As Mack puts it, "When you think about what a bank does for customers, it takes deposits and makes personal loans. You don't need to go to a bank to do that."
In the UK, the Bank of England and deputy Prime Minister, Nick Clegg, are talking about peer-to-peer lenders as a viable alternative to high street banks in a world where credit is tight and expensive. "Small peer-to-peer lenders like Zopa and Funding Circle could in time replace high street banks," Clegg said in an address to the UK parliament. Around the world, social lending is on the rise and it can be expected to be big in South Africa, too.
So, what has caused social lending's worldwide rise? The global economic crisis is certainly one factor. Trust is one of the biggest assets any bank owns and faith in the banking sector has been shaken to its roots by financial turmoil. Against this backdrop, people around the world are questioning why they should not take back a bit of the power they have traditionally given to the banks.
Another reason people are looking to social lending is that they are becoming more and more comfortable with social networks and crowdsourcing. From group buying to open-source software to social sharing of news and information, we count on the crowd for a range of needs. Why not social lending, provided it's transparent and well-managed?
Social lending is ultimately about people power. Consumers are beginning to understand that there is something fundamentally flawed in a model where banks loan money out at prime plus two or three, take cash deposits on interest rates below prime and pocket the difference, in addition to a range of charges and fees.
For that, reason, the rise of social lending could pose a serious threat for South Africa's banking oligopoly. It is a direct challenge to them to innovate and drive some of the high costs and complexities out of their lending models after years of stagnation in product strategy.
In South Africa, we have had social lending in an offline form called stokvels for years. According to AMPS 2011, 40% of the South African population currently belong to a stokvel. There are around 811,000 stokvels with an estimated value of R44 billion in South Africa. Specialised social lending platforms essentially bring stokvels into the Internet age.
By taking care of administration, collections and scale, such person-to-person lending marketplaces could grow to 100 000 member communities of people lending to and borrowing from each other. This would provide for huge scale and dramatically reduce risk.
No one is better positioned for social lending than banks with their systems, infrastructure, and customer credit data, for example, but they have chosen to ignore the trend, perhaps hoping it will completely bypass South Africa.
With new players ready to challenge the large industry players, they may soon discover that South Africans are looking for better ways to manage their finances. Consumers are looking for ways to free themselves from the debt management issues and high interest rates of the formal banking sector. Person-to-Person lending may be the alternative that many of them are looking for.
If the global growth numbers are any indicator, social lending is set to explode in South Africa, too. If it does, expect to see some of the most exciting changes we have seen in the local banking sector for years as banks start to rethink their traditional approaches to cash loans.
