Reducing Friction in the Personal Credit Market...
Free markets work to reduce friction. When I talk about friction I’m referring to the something that adds a burden that is outsized to the value provided. An example of this was the previous bid system in the stock markets. Bid and ask increments were forced to be a quarter or even sometimes a half dollar apart. Did the market maker really provide a quarters worth of value per share? Did he provide 50 dollars of value when you traded 100 shares? No! High cost with low value. Friction. Of course this system was recently replaced by penny increments reducing the friction and leaving more money in the hands of buyers and sellers.
The same thing applies in the personal credit market. Two years ago I was opening a checking account when rates were a bit lower than they are now. The bank I was at charge over 20% interest on its credit cards. The clerk asked me if I wanted one of their savings or money market accounts. I asked what the rate was and threw out a guess of 1.5%. The clerk laughed and responded “Isn’t that cute”. The actual rate? 0.2%. Ouch. That’s a whole heap of friction.
I think that a wave is about to break over the personal credit market that sands this high friction surface to a silky smooth finish.
I’ve been writing about Prosper.com’s peer to peer lending model for a while now. It is very clear to me that given the disparity between the rate consumers receive on their money and the rates that financial institutions charge consumers that there is room for a profit in between the extremes. Prosper is already knocking the rough edges off the personal credit market. The spread between the borrower and lender rates is around 1-2%.
Zopa, a UK P2P (peer to peer abbreviated for all you folks not in touch with your Web 2.0 slang) company, is moving into the US market. Zopa’s model is different than Prospers. More detail on that later. What you should know is that it will put more pressure on the margins in personal lending and that should ultimately be good for us all. Lower rates for consumer borrowers. Higher rates for consumer lenders. I’ll take it.