Amateur Bank Lending
By Arnold Kling
About $100 million in new person-to-person loans will be issued this year, and that will increase to as much as $1 billion in new loans in 2010, according to a recent study by Online Banking Report, a research firm.
Andrew Balto Jr. of Churchville, Md., says he pulled some money out of certificates of deposits and money-market accounts last year to put into Prosper loans, where he is now earning returns equivalent to an average annual interest rate in the midteens. “What really attracted me were the rates people were paying for the loans,” says the 39-year-old small-business owner, who has about $30,000 spread out over 350 Prosper loans. He says those loans make up only a small part of his total investment portfolio.
I think there’s something wrong with this picture. As an individual, I do not have the time or the resources to evaluate a borrower’s riskiness or to deal with late payments or defaults. That’s what banks are for–I deposit my money in the bank, and the bank deals with individual borrowers.
By doing the lending directly, I get a higher interest rate, because I don’t pay the bank to do anything. But I expose myself to a lot of downside risk.
What worries me the most is that I do not know how much time and effort I have to put into weeding out borrowers. It depends on what the other amateur bankers are doing. If they aren’t putting in any effort, then fine, I can throw darts and get a random sample of borrowers. But if my competitors are putting a lot of time and effort into sifting, then unless I match their efforts, the borrowers I get stuck with will be all the dirtbags.
Nick Schulz, who sent me the pointer, says that it is indicative of our high-trust society that such a market even exists. It is true that institutional advances allow for remarkable transactions to take place among strangers. However, person-to-person lending between strangers strikes me as a market that cannot, and in the long run will not, work.
By the way, the movie “The Call of the Entrepreneur,” which is being shown tonight at the Heritage Foundation, has a good explanation of the role of financial intermediaries in making risky lending possible.