Are 'social bankers' our future creditors?

One of the defining features of 'web 2.0' has been user-generated content. Internet users can write and edit Wikipedia entries, buy and sell on eBay, create profiles and develop applications on Facebook, and leave political comment on blogs.

The phenomenon of user-generated content also extends to banking. 'Social banking' websites claim to be taking on major banks, allowing internet users to borrow and lend money to each other (with borrowers setting their own interest rates), thereby cutting out the middleman. Sites such as Zopa in the United Kingdom and Prosper in the United States allow borrowers to access cheaper rates than they could obtain from mainstream competitors, while lenders can obtain a higher return on their cash than they would get from savings and other deposit accounts:

• Zopa.  In the case of Zopa -- developed by some of those who came up with leading UK internet bank, Egg -- the website charges a small feel to borrower and lender, and sells add-on products such as payment protection insurance. In return, it is responsible for vetting borrowers, chasing late payments and other administration.
• Prosper.  On Prosper, lenders can see profiles of their potential clients, detailing their circumstances and why they need loans.  Zopa is launching a similar facility, which adds a human dimension to social banking, and creates the online community that has been an essential feature of other user-generated content sites; while allowing borrowers with less than perfect credit histories to argue their case.

So will Zopa and Prosper do for banking what eBay has done for online retailing? Certainly, Zopa appears to be expanding, now offering services in the United States and Italy, with plans to launch elsewhere in Europe.  However, the model has flaws:

• Social banking lenders may have access to imperfect information, or have non-economic motivations, meaning that interest rates, particularly to the most credit worthy borrowers, are often unrealistically low, making them unattractive to potential lenders who could secure better returns from high interest deposit accounts.
• Because social banking is often a better deal for borrowers than lenders, there is no guarantee that there are always enough lenders' funds on offer at appropriate rates. In particular, the prevalence of funds being offered at very low rates means that lenders seeking higher returns -- better than deposit accounts -- frequently have difficulty lending out their funds.
• Most fundamentally, social banking, particularly at relatively high interest rates, represents a risk to lenders. If the current credit crunch worsens, this may make potential lenders unwilling to invest money in this way, particularly given that savings rates remain relatively high.

Social banking is undoubtedly here to stay. However, inherent problems in the system, combined with bearish credit conditions could mean that it will not be the phenomenon that other user-generated content has become.