The term social lending has become more and more common in discussions of economics, lending and investing. Social lending (also known as peer to peer or P2P), is generally defined as individuals borrowing money from other individuals, instead of borrowing from a bank. In some places, this transaction is facilitated by an online platform. Of course, how social lending works does vary significantly throughout the world as this practice has been adopted in many countries. The exact form of lending and the terms are different in most countries and many countries restrict social lending/borrowing to people who reside in that country.
Pros of Social Lending
- In many places, borrowers do not have access to banks and traditional lending institutions for personal loans or to start a business. Social lending may provide funding that is otherwise not available.
- For borrowers that may have access to traditional lenders or may need to go to an underground lender, the interest rates available may be very high. Social lending may offer funding at more reasonable interest rates.
- Many borrowers in developing countries are looking for relatively small amounts of money, which makes the transaction too costly for traditional lenders. Social lending platforms can keep costs low and facilitate a large number of transactions with limited costs.
- Investors can get a higher return on their money than they would with a bank account. Returns can be even higher for riskier loans so investors need to be careful and ensure that borrowers are likely to repay the loan.
- Lenders may see benefits to their own community by using their investment to strengthen the local economy.
- Investors can diversify their investment over a large number of loans, making defaults less impactful to their peer lending investing portfolio.
- Borrowers can get funds for a large number of reasons and uses which gives them a lot of flexibility to meet their needs.
Cons of Social Lending
- Underwriting standards vary based on location and platform, therefore, these policies may not adequately protect investors.
- For a variety of reasons, including the one mentioned above, investors may lose all or a portion of their investment. Investors who are not savvy and knowledgeable about social lending are placing their money at considerable risk.
- In some cases the fees for borrowers and/or lenders may be high. This makes these loans less attractive to both investors and borrowers.
- Less sophisticated platforms and arrangements may not provide necessary information to either the borrower and/or the lender. This can make social lending riskier and more expensive for one or both parties.
Clearly, social lending offers a viable alternative to traditional lending for borrowers, while offering a new and valuable investment for investors. The popularity of this arrangement has increased every year since its inception about fifteen years ago. Many countries have created legislation to protect participants. In addition, platforms have become more sophisticated which makes this arrangement safer for all parties. These trends indicate that social lending will continue to grow and evolve. To what extent and in what areas depends on cultural, political and economic factors that are specific to every country, region or even town.