By Christina P. O’Neill
The emergence of peer-to-peer (P2P) lending as a vehicle for non-banked or underbanked people to get business loans and to develop or improve their credit history has become a financial feel-good story in an era of financial re-adjustment. P2P has caught the attention of nonprofit organizations and credit unions, which have started to underwrite and support these endeavors. The concept has emerged in Massachusetts in recent years as nonprofit organizations teamed up with credit unions to offer P2P loans to their targeted populations.
Peer-to-peer lending takes several forms. In pure-concept lending circles, members of the circle pay periodically into a pool from which each in turn draws. The recipient of the first round of funding gets everyone else’s upfront funding; the last recipient has paid into the pool for the life of the pool before getting the funding.
In another form of P2P lending, investors are matched with borrowers and there’s no waiting turns in the pool. An example is San Francisco-based Prosper.com, which helps match those who want to start their own business with prospective investors, like an experienced housekeeper or cook who seeks to start a cooking or catering business of their own. Both forms of lending are highly personal, but both offer potential to get their participants closer to establishing a credit history.
But the P2P concept has a long way to go before entering mainstream banking, due in part to the economic challenges faced by the immigrant communities that originated and developed the lending circle concept in the first place.
Brockton-based HarborOne has not had direct experience with lending circles and therefore did not comment on them, but its upfront work with the immigrant community shows the extent of the work that is needed to help underbanked customers.
In a statement, a bank spokesman said that HarborOne has worked extensively with the Cape Verdean community in the Greater Brockton area around financial education, including helping the immigrant community understand how to access mainstream financial resources and the importance of building good credit. HarborOne U offers a four-part class called “Finance Success,” often taught in the participants’ native language, which shares many of the core values that giving circles embrace – establishing and building good credit, understanding credit and credit scores, building good money management skills, etc. After completion of the class, the participant can open an account and be eligible for a $500 line of credit. After 12 months, the initial $500 credit line will be increased to $1,000 if the participant demonstrate that he/she can manage his/her budget and credit.
A quicker vetting process
“Any platform like [Prosper.com] needs a middle person doing the protective work,” said attorney Michael Whalen, a partner in the Washington, D.C., office of Goodwin Procter. Risk-protective aspects exist now, he said. A broker can underwrite an initiative, taking on the traditional lender function and assuming the underwriting role of banks, but in a way that’s faster and more automated.
The advent of social media as a way to connect P2P borrowers and lenders offers a much wider contact base than was available in pre-Internet days, but it has essentially jammed the supply-demand chain with new input, bringing with it a growing need to vet the participants.
Whalen indicates that the classic safety measures for underwriting still apply to social-media participants. Underwriters and other investors can decide to set interest rates based on levels of risk, indicating a wider flexibility in setting rates of return, which can go up to the 10 percent to 12 percent range. This can result in a combination of philanthropy and return on investment.
Can they make it on the outside?
As P2P borrowers fulfill their loan commitments in the nonprofit band, will they be able to cross over into the wider banking system in today’s tightened regulatory environment? Recent news reports indicate an effort to disclose the beneficial impact on credit scores as a result of participation in P2P enterprises. That’s all to the good. But the caution will be not borrowing and overextending too fast based on the genuine credit history gains from smaller loans. A combination of the personal relationship and the professional underwriting function will likely be needed to develop a new cadre of mainstream banking customers.