Peer-to-peer lending involves lending money to people unrelated to the lender. Depending on the arrangement, these are usually unsecured personal loans ranging from smaller to larger amounts. Peer-to-peer lending, or P2PL, bypasses traditional financing routes such as banks and other institutions. It differs from peer-to-peer investing (P2PI), primarily concerned with lenders.
Peer-to-peer lending may be arranged through companies specializing in setting up such connections between peers and is often done online. Peer-to-peer lending is often conducted for individual purposes, although it can sometimes be an aspect of small business loans (especially smaller “mom and pop” type businesses).
Peer-to-peer fundraising promotes supporters of a charity or non-profit organization to raise funds individually. Rather than having one main crowdfunding page where everyone donates, people can create multiple individual fundraising pages with peer-to-peer fundraising, which they will share with their networks.
Many peer-to-peer loans are unsecured personal loans, though some of the largest amounts are lent to businesses. Sometimes, secured loans are offered by using luxury assets as collateral, such as jewelry, watches, vintage cars, fine art, buildings, aircraft, and other business assets. These loans can be given to individuals, companies, and charities. Peer-to-peer lending also includes student loans, commercial and real estate loans, payday loans, secured business loans, leasing, and factoring.
Interest rates can be set by lenders who fight for the lowest rate on a reverse auction model or by an intermediary company based on the borrower’s credit analysis. Government guarantees do not normally protect the lender’s investment in the loan. Depending on the service, lenders may mitigate their risk of bad debt by choosing which borrowers to lend to and by diversifying their investments among different borrowers.
A lending intermediary generates revenue by collecting a one-time fee on funded loans from borrowers and by charging either investors or borrowers (either a fixed amount annually or a percentage of the loan amount) a loan servicing fee. In comparison to stock markets, peer-to-peer lending tends to be less volatile and less liquid.
Peer-to-peer lending in the U.S. began in February 2006 with the launch of Prosper Marketplace and LendingClub. Prosper and LendingClub are both based in San Francisco, California.
Peer-to-peer platforms had few restrictions on borrower eligibility in the early days, which caused adverse selection problems and high default rates. Furthermore, some investors viewed the lack of liquidity for these loans, most of which have a minimum three-year term, as undesirable.
In 2008, the U.S. Securities and Exchange Commission (SEC) required peer-to-peer companies to register their offerings as securities under the Securities Act of 1933. The registration process was arduous for Prosper and LendingClub, while others exited the U.S. market altogether. LendingClub and Prosper were approved by the SEC to offer investors notes backed by payments from loans.
Prosper amended its filing to allow banks to sell loans they have previously funded on the Prosper platform. In partnership with FOLIOfn, LendingClub and Prosper created a secondary market for their notes to provide liquidity to investors. Prosper had a mandatory registration at this time, whereas LendingClub had a voluntary registration.
As a result, as opposed to traditional securitization markets, the loan requests of peer-to-peer companies were more transparent for lenders and secondary buyers, who could access detailed information about each loan before deciding which loans to fund. In addition, peer-to-peer companies must regularly update their prospectuses to describe their services. The SEC makes the reports available online via EDGAR (Electronic Data-Gathering, Analysis, and Retrieval).
As a result of the financial crisis of 2007-2008, more people turned to peer-to-peer companies for borrowing. As borrowers defaulted more frequently, investors were less willing to take on unnecessary risk in the peer-to-peer market.