The reaction of bankers

As I mentioned a week or so ago, I've spent the better part of this week at CLAB in Latin America. I gave a presentation about the future of retail banking channels, and my conclusions were, essentially, that non-traditional players in the market, such as Paypal and Prosper.com, were doing something very new to the banking business. For the first time ever, I argued, the special economic role of banks as the primary intermediaries between actors in markets is being challenged. Previously disruptive innovations in banking, (for example, Internet Banking) didn't actually interfere with the special role that banks have in society. Non bank payment systems and P2P lending? These go right to the core of what banks have traditionally done.

My point was that the business model of banking itself is now being touched by parties that aren't banks.

This was a fairly controversial position to take, I admit. And it was one that wasn't universally agreed upon. I had one banker come up to me afterwards and accuse me of outright lying. He was simply unable to believe the numbers I showed justifying my conclusions. Many others have come up since then asking for the data. 

So what data is this I am referring to anyway?

Prosper.com have taken the unusual step of allowing you to query their business model directly. You can go here and get all the information you wanted about how much business they are writing, the default and arrears rates, and much more. This is a smart move on their part: it makes their business transparent. How many new loans written today? How likely is it that I'll suffer a default? Prosper will tell me. If I'm a knowledgeable investor, this is data I'm going to be looking at before committing funds.

So, what are the conclusions from the data I've looked at? Firstly, there is rapid growth in the Propser business. When you average the number of originations per month since January, I'm seeing a growth rate of just over 32% per month. In July, they wrote $235,000 in business. On average since launch, the value of loans originated is increasing 38% per month, although in June and July there was a substantial reduction in this growth rate. By my calculations, there's about $10 million in the loan book at the moment (not counting deals done in August). Fee revenues from that are $100,000 to Prosper, and don't include servicing charges levied against the lender which are an annual 0.5% per annum calculated daily, or any of the other charges that are levied for non electronic payments or over-dues.

Now admittedly, in the scheme of things, that's not a large amount of revenue. But consider the cost side. Interest Expense? Zero. Regulatory costs? Must be quite close to zero. Administration charges? Probably not that much different to an ordinary (small) institution. Interesting economics.

Here's something else I find rather interesting: if you take an average since January, Prosper have less than one half of 1% of loans in arrears at any one time. That's low. Could this be something to do with the social networking side of the site?

Today I came across this Deutsche Bank report on P2P lending. Although it seems light on real data, it points out  something that I'd missed in the Propser data: only 30% of loans posted actually get funded. In other words, there's more demand for loans than there are people looking to lend. We're back to the perennial banking problem - how to attract deposits.

I'd rather suspect that this is a short term problem - after all, the business has only really been going since January. It may be that word-of-mouth will fix this issue by itself. You only have to look at the power of social networking sites like MySpace.com to see how many people can get involved in something new without that much effort from the site owners.

In the meantime, the upside in the loan book for Prosper is substantial if only they can get more people with money to consider P2P loans a good investment.

What was my conclusion from all this at CLAB? If Prosper and Zopa really work well (signs are good!) it would seem to me that bankers need to get on the bandwagon themselves. There are certain classes of product - for example a mortgage - that involve quite a bit of stuff other than a movement of money. Banks are expert at these things. Tie that together with the new business model and something quite interesting could emerge.

Actually, I think that the banks that choose to partner with non-bank sites like Zopa and Prosper (and do it before the competition) will be on a winner. 

Comments

[Colin]

I am shocked but not surprised at the reaction you got. Generally speaking bankers are good at rationalising why risks shouldn't matter. It seems to come with the territory.
Internet as a disintermediator worries me too. P2P lending is one as you say. In fact its disintermediating loans and deposits. Paypal worries me. Social Networks worry me. These are all opportunities for smart banks.

[Andrew]

James,
This business model is not so much dis-intermediation as reduction in some of the scale of intermediation. The real issue is in the risk transfer.
When it comes down to it, no matter how much people complain about banks they trust them to give them "their" money back on demand. Can they trust an unknown counterparty to do likewise? The pooling, and the resulting reduction, of risk is still a core function of banks and I doubt this will change.
If I am wrong any one of the banks could buy / compete with these players fairly quickly.

[James Gardner]

Hi Andrew,

I think one the key things is that risk *is* pooled with this model. As an investor, you would fund a basket of loans, just like a banker. Any loss would be factored into overall rate of return.

It is probably true that only sophisticated investors would understand this, I expect.

Having said that your point is a valid one, and, since only 30% of loans funded, there is every chance that people are worried about their moeny.

It is one of the major issues that Propser.com will have to address I suspect.

[John Januszczak]

With the conversion and electronification of payments (e.g. image exchange and remote deposit capture in the US, TECP in Canada) the role of banks as the primary intermediaries is also questioned. Look at WalMart's application for an ILC - a perfect vehicle for handling payment processing and bypassing the banks. Perhaps not as sexy as P2P, and decidedly more on the commercial than retail side, but it shows this erosion of the traditional role of banks can erode on so many levels.

[Michael Schoeffler]

It's important to squint at prosper/zopa, instead looking dead on. These companies are only indications of their futures.

Partly, they both need to implement some basic fixes to their models to make life easier easier for their customers. Right now, they're on version 1.0.

Even more, they need to achieve critical mass. It's the difference between a couple of guys in funny shoes meeting under a buttonwood tree in bucolic Manhattan and the enormous value generated by the NYSE.

That 30% figure will soon become a historical data point. Once this marketplace matures, there's a lender for every borrower.

Mike

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