The marketplace model of person-to-person lending on the internet enables peer lenders to locate peer borrowers and vice-versa. This model connects borrowers with lenders through an auction-like process in which the lender willing to provide the lowest interest rate "wins" the borrower's loan. The marketplace process may include other intermediaries who package and resell the loans, but the loans are ultimately sold to individuals or pools of individuals.
The "family and friend" model forgoes the auction-like process entirely and concentrates on borrowers and lenders who already know each other, as with two friends or business colleagues formalizing a personal loan. Whereas the primary benefit of the marketplace model is the "match making" aspect, the family and friend model emphasizes online collaboration, loan formalization and servicing.
Traditionally, lending institutions have benefited from scale and diversification. By pooling the available money supply and lending it out again, the impact of any one default is made trivial in light of the timely payment of the vast majority of the notes outstanding. The downside to this model is that it has introduced greater transaction overhead and removed community loyalty from the equation. Person-to-Person or Peer-to-Peer Lending models attempt to reintroduce the social components that are lost in traditional centralized banking models, while maintaining a mixed quantitative/qualitative balance of diversification - as opposed to the purely quantitative diversification available through institutional lending. They also attempt to take advantage of the lack of overhead, thereby reducing the traditional bid/ask spread implicit in traditional bank lending models. For example, a bank may offer its deposit customers a meager 1% return, yet, at the same time, lend those same customer funds out for a much higher rate of interest. Peer to Peer Lending attempts to correct this inefficiency and create a "virtuous cycle" which would allow those who have funds to lend to garner a better return, while, at the same time, providing a more favorable interest rate to those who need to borrow. It also allows individual participants to directly control their own funds, as opposed to the traditional banking/lending models which pool all funds together and completely remove individuals from decision-making.
Community lending is a form of Peer-to-Peer Lending which involves intra-group many-to-one or one-to-many credit structures. It has as its theoretical premise the notion that pre-existing interpersonal relationships or other types of social connections between the transacting parties will foster increased fiscal responsibility and thereby improve repayment performance.
Similar types of mutualized credit systems are already quite often successfully employed by microfinance institutions in developing nations. For example, a microfinance institution may make a loan to an individual who is a member of small group in a certain locale, but may structure its lending agreement to hold the borrower's "social group" either directly accountable for the repayment of the loan (akin to "cosigning") or indirectly accountable (whereby the entire social group may face future consequences, such as reduced access to credit or higher future rates, if one of its members fails to repay an obligation). The principle behind this form of transaction being that it is better to diversify risk over a smaller pool of "related" individuals, rather than just a single borrower, so that the borrower's immediate community- or social-group could be positively incented to affect repayment, either through mutual ("community") support of the borrower or, as occurs in some instances, through forms of social pressure. Community lending, however, occurs (rigorously) "only" when this form of lending and borrowing is transacted on a purely intra-group basis between members of a specific community (without the involvement of a corporate institution on one side of the transaction - though the argument can be made that this model, in some ways, serves to "incorporate" pre-existing social groups).
In 2005, there was $118 million of outstanding peer-to-peer loans, and there were $269 million and $647 million in 2006 and 2007 respectively. The projected amount for 2010 is $5.8 billion.
With the increase in trade and commerce, society evolved institutions which acted as intermediaries between lenders and borrowers.
Disadvantage to this model developed over a period of time :
Intermediaries charged the spread for the following reasons :
With the growth of internet technologies new business models evolved to remove the intermediaries like
A natural extension of these was person-to-person lending or peer-to-peer lending. In principle two models have evolved in the P2P lending space: secured P2P and unsecured P2P lending.
In this model, the lender gives money to the borrower against the strength of the collateral given by the borrower. The advantage of this model is that the capital and interest of the lender is secured to the extent of the realizable value of the collateral. The Dis-intermediator provides risk management as per the terms and condition agreed upon by the lender and the borrower.
In this model, the lender gives money to the borrower based on the credit rating of the borrower. The lender runs the risk of the capital and interest in case of failure on the part of the borrower. Two variants have evolved in this space.
Pooled Lending - the lender lends the money to a pool of borrowers with similar credit ratings. In this model the risk of capital and interest for the lender is defaulters in the pool. The risk of capital and interest of the lender is reduced considerably. See Zopa or Lending Club for examples.
Direct Lending - the lender lends money to a borrower based on their credit rating. In this model the risk of capital and interest for the lender is that the borrower could default on the loan. See Kiva, The Open Source Science Project, Prosper or Loanio for examples.