Can Lending Club jump-start banking?
September 15, 2011
Banking is in a rut. Rates on CDs, savings accounts, and money market accounts are near zero. Potential borrowers have trouble finding willing lenders. Can organized peer-to-peer lending, through organizations such as Lending Club, give the banking system the shake-up it seems to need?
Lending Club is a company which solicits capital from investors and uses that capital to make loans. Because it bypasses much of the cost and bureaucracy of the traditional banking system, Lending Club offers to give investors higher returns while offering borrowers more attractive loan rates. Can this work?
While the prospect of doing better than today's CD, savings, and money market rates is certainly appealing, there are three things you should know before you put your money into a peer-to-peer lending program:
- Underwriting standards are critical. Peer-to-peer lending is no different from traditional bank lending in this sense: it is only profitable if the vast majority of borrowers pay back their loans on time. So, before you invest, you will want to make sure you are confident in the standards the loan organization is using when it lends people your money.
- The math has to add up. Perhaps it is natural for Lending Club to put forward its most favorable numbers, but you need to view the figures with a critical eye. Obviously, when they tout a borrower's rate of 6.78 percent and investor returns of 9.64 percent, they are mixing and matching the numbers somewhat selectively. Overall, the average investor return cannot exceed the average borrowing rate.
- These are not insured deposits. You should consider peer-to-peer lending an investment which carries some risk of loss of principal. The safety level is not comparable to FDIC-insured savings accounts.
There is no doubt that peer-to-peer lending can be a good deal for borrowers--it opens up new options for people trying to qualify for a loan and find lower interest rates. Whether it is a good deal for investors depends heavily on how much risk is being taken by making those loans, and how well the investors understand that risk.