Sunday, April 01, 2007 a bit of analysis and forecast then?

The hype nowadays is all about helping regular folks become a bank and make loans. Or in the Netherlands: And the fun bit is of course that people are very keen on outsmarting those big bad banks. Now, let's have a look at reality then and assume that I have two options for putting 500 euros of my money aside. One option is to throw it at a mediocre internet savings account at a real bank which gives me some 3 %. So at the end of the three years, I end up with € 546.

Now let's assume that I split up the 500 euro into 10 bits of 50 euro and that Prosper is not charging me anything for their service. I lend my money to a bunch of 10 people who offer me interest rates of 5, 8, 7, 9, 3, 4, 11, 12, 6, and 7 percent and promise me to repay after three years. On average this gets me a 7,2% return and after three years I end up with about € 608 euro. Sounds great.

That is, if you forget about the odds. Because chances are that one out of those ten may not be able to pay or repay you. If for example you would assume that the highest borrower (12 % interest) is bailing out after year 1, I end up with almost exactly the same amount of € 546. And with two out of the ten failing me as I provider of money, I end up with € 508 (worse then with my mediocre Internet savings account).

Now, with all this cold rationality one would expect Prosper not become such a hype. And one would expect a bit of analysis explaining that any mediocre bank is on average a better risk taker than you as a would-be bank can ever be. So fun as it might be, you will in the end financially be better off with a bank rather than with Prosper.

But, here's the catch. While financially it may indeed make more sense to put your money in the bank, the thing the bank can't do is explain the destination of your savings money. The bank does'nt give you the sense of feel-good, fun, usefulness for society if you move your funds there. And Prosper does. It allows the lenders to engage in the fun/usefullness of what lending money is all about. One has to evaluate the borrowers proposal, the borrowers position and decide whether or not this borrower can be trusted or, whether or not one doesn't care if the money's gone, given that the borrower has a charitable cause (or a nice face).

So what Prosper provides to the public, is not so much the hard financial benefit in saving/lending but the human factor involved on the lending/savings production side. And my personal guess is that people are actually more than willing to pay for being personally involved in determining where their savings money goes. Which means that they won't care if their money doesn't make as much as with any mediocre bank. So that's the real reason why Prosper will be a succes. The consumer wishes to pay (or suffer financial loss) to be a producer him/herself.

Now, let's take the crystal ball to look some 10 or 20 years ahead.
I imagine that we will see:
- banks allowing their customers to direct their savings to specific borrowers (identified by names and life stories or generic characteristics),
- some customers that choose money for their money and go to banks with their savings, and others that use Prosper to choose for return on investment in terms of personal engagement rather than financial revenues,
- some priviliged target groups (low interest student loans, provided by governments) may use up their priviliges and borrow to the fullest extent for a low interest fee while lending out for a bit more (leading in some cases to actual further debts by having unsuccesfully acted as a bank),
- the public, starting to better understand the financial intermediairy role of banks in society,
- the public starting to appreciate (after having unsuccesfully tried to outsmart banks in financial terms) that banks actually do quite a good job at this savings/lendings business.

So do check back here in 10 or 20 years and we'll evaluate this prediction.