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Think outside the bank

For the first few months, Renaud Laplanche financed his software company with credit cards. Then he looked at the statements. “It’s painful when you realize you’re paying 18 percent,” he says. So he hit up some well-heeled friends from his sailing club, and they spotted him about $35,000 at 10 percent interest—enough to pay off his credit cards and support the enterprise until venture capital came through with more generous funding.

As he struggled, did Laplanche ever consider going to the loan officer at his local bank? No way. Borrowing from a bank is a slow, bureaucratic process, he says. It’s also often off-limits to people outside the wage-and-salary mainstream, whether they’re starting businesses or getting back on their feet.

“A bank is a place where they lend you an umbrella in fair weather and ask for it back when it begins to rain,” said the American poet Robert Frost. After all, as a cobbler and poet without a college degree, he probably couldn’t have gotten a loan either.

Banks’ shortcomings have been recognized for centuries—and for centuries, groups of people have been organizing themselves to take advantage of alternatives. In the mid-19th century, a pair of German economists extended the growing idea of “co-operative societies” to credit. By 1864, a group of farmers had joined together to secure loans for livestock, seeds and farming equipment, forming one of the first credit unions, a co-operative, community-based banking model that still thrives.

More recently, in the last 30 years, the rise of microcredit has brought many small loans to people in poor countries and rural areas who had no access to traditional banks or could not present the kind of bona fides a bank requires. Microcredit has sparked a revolution in the international development community, proving the existence of plenty of credit-worthy people who are simply overlooked by traditional banks.

Combine the principles of microfinance and online social networking, and you get a new phenomenon: peer-to-peer lending, or social lending as it’s sometimes called. In the last two years, more than a dozen websites have been launched to connect borrowers and lenders—no banks required.

Every site has its own twist. Most allow anyone to ask for a small loan, usually less than $25,000. Some play on users’ social ties, whether they’re true offline connections, like a shared alma mater, or online groups created expressly for borrowing. One site, Kiva, is using the concept to fund no-interest loans in developing nations (see story below).  

Peer-to-peer lending appeals to lots of people. Americans already lend more than $89 billion to friends and family every year, according to Federal Reserve estimates. Nearly 75 percent of Britons said they’d consider using a peer-to-peer website to borrow or lend, and some estimates suggest the global market for peer-to-peer lending will grow to more than $5 billion by 2010.

In poor countries, demand is even greater. The Microfinance Information Exchange tracks more than 1,000 microlenders that control more than $10 billion in loans. From Indiana to Ireland to India to the Ivory Coast, that’s a lot of people bypassing traditional banking.

While cutting out the middleman may be instinctively attractive to many people, it can have an economic advantage too. Compared to credit cards, peer-to-peer lending offers borrowers really attractive interest rates—often half what they might expect to pay Visa or MasterCard.

And peer loans are often structured more fairly. A debt can be paid off in installments, unlike with credit cards, which can trap borrowers under debt that snowballs every month. For lenders too, these loans offer a higher rate of return than what they can earn on savings accounts. Interest is important, say small lenders.

“Interest rates turn a charitable relationship into a business relationship,” notes Matt Flannery, who founded the online microlender Kiva.org in 2005. In Kiva’s context, “that empowers the poor by making them business partners.” Right now, Kiva lenders don’t earn interest on their loans—but the underlying microlenders, which administer the loans in their countries, do. Regardless of whether a loan is for a tamale stand in Veracruz or a tech startup in Valencia, borrowers can get money at lower rates, which makes for a shorter path to a sustainable business.

It is that goal—getting capital to people who need it at reasonable rates—that creates a strong sense of purpose and community in social lending. The sites promote personal ties between lenders and borrowers. And with the global reach of the Internet, borrowers no longer need to know someone with money to secure a loan. By the same token, lenders often feel they’re helping a real person get through a bad patch or realize a dream.

Traditional bankers have a hard time seeing it that way. “They’re dumbfounded,” says George Hofheimer, chief research officer for the Filene Research Institute, a Wisconsin firm that studies consumer finance. “Why would anyone lend money to strangers?” The banking establishment, after all, considers itself expert at evaluating the risks involved in lending money. Social lenders concede that point. Lending is risky, and peer-to-peer sites often use the same tools—credit reports, income verification—to judge how stable a borrower is.

But banks also have a vested interest in remaining the middleman, and they’ve never been quick to adapt to change. Industry observers point to the success of the online bank ING Direct, which caught brick-and-mortar banks unprepared, and say peer-to-peer lenders may have a similar effect.

After all, people take their money personally. Increasingly, investors want to make money and do good at the same time. Social lending lets them do exactly that.

“What happened to me was great,” says Laplanche, the software entrepreneur with generous friends. “Why couldn’t that happen for people who don’t have a sailing club?” He teamed up with John Donovan, a 17-year veteran of the credit card industry, to launch Lending Club, a lending network based on groups of friends and alumni connected through Facebook.

“It’s my joke that I’m finally giving back,” Donovan says. Lending Club is counting on community loyalty to encourage lenders and borrowers, but there are plenty of other models, from Prosper’s open exchange (see story below) to Kiva’s social-justice mission to the Dutch business-to-business marketplace Qoin (see story below). All offer different ways to borrow—and the potential for lenders to make a difference.

Let the funding flow

Julius Ocola wants to start a water company. Ocola, 52 , married with five children, lives in the Acholi Quarter, a neighbourhood on the outskirts of Kampala, Uganda, which is carved out of a muddy hill near a rock quarry. Most inhabitants here eke out a living by cracking rocks into gravel. Few earn more than a dollar a day. Food is scarce. Water is too. Residents walk a mile into town and carry water back in what look like large oil cans. It is expensive and time-consuming. So Ocola wants to start a water company—by tapping into a water line beneath the heart of the Acholi Quarter.

Yet his idea requires money. Ocola thinks his water company will take 800,000 Ugandan shillings, or $475, to start. But there’s little funding available in a poor African neighbourhood. Banks charge as much as 35 percent interest; moneylenders ratchet that rate up to 300 percent. Luckily, Ocola can upload his business model onto Kiva.org, which allows anyone to loan money to developing-world entrepreneurs.

Lenders provided almost $10 million through Kiva in the first seven months of 2007. Currently, Kiva loans do not generate interest to lenders. If entrepreneurs don’t make good on their loans, lenders lose out.

Shortly after Ocola uploads the profile of his water company, someone in La Jolla, California, takes interest in Ocola’s story. The California resident charges his credit card through PayPal. Ocola gets the money for his company. Water begins to flow into the Acholi Quarter. —Andrew Tolve

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One good turn leads to another

A new currency for social business.

Hanneke Rombouts runs a bed and breakfast and conference centre, Veerhuis (“ferry house”), in the eastern Dutch town of Varik. She wasn’t able to get a conventional bank loan for a much-needed renovation and building upgrade. Then she discovered Qoin.com, a trades network for social entrepreneurs. These business owners can fund each other’s products and services, paying partly with “qoins”—a new barter currency (1 qoin is equal to 1 euro or about $1.35).

“The renovation has just been completed,” Rombouts says. “The Veerhuis has a new room and a roof garden that looks out over the Waal river. But now I need furniture too and have no more money.” She’s now looking for chairs, beds and tables via Qoin. She’s also had business cards and brochures designed and printed at companies that are part of the network.

Launched last summer, Qoin was set up by Rob van Hilten, who 15 years ago started Noppes, a Dutch barter site for low-income people. His new initiative is aimed at companies with gross incomes from about $600,000, and small independent entrepreneurs. The growing network now has 100 participants, from an advertising agency and printer to a natural building materials supplier. Van Hilten’s business partner Edgar Kampers now lives and works in Norway, where he’s setting up another Qoin network.

“Money is the lubricant of society,” declares Van Hilten. “We use Qoin to make the world a somewhat better place by focussing on companies that do more than just turn a profit. We want to use it to boost their businesses.”

But, he emphasizes, “Qoin is not a bank.” If participants have a negative balance, they have to supply products or services to other members of the network in the future. Hanneke Rombouts is one such example. “Through the qoin, I got a great group of guests, including several young philosophers and a couple of mud-plasterers,” she says. “They paid half in qoin, which allowed me to clear my negative balance. They paid the other half in euros, of course, because my staff expects me to pay in euros.” —Ineke Noordhoff

Everyone's bank

The website that lets you profit by helping worthy enterprises.

Last year, Chicago fashion designer Lara Miller was short on cash; revenue from the previous season’s sales still hadn’t hit her account. Miller needed a $3,000 loan to pay for promotional material for her line of ethical clothing, but was turned down by three banks. The reason? Miller, 27, had no history of borrowing or any collateral. “It’s frustrating,” she says. “How are you supposed to get your business started?”

The solution lay outside the traditional banking system. A friend introduced Miller to Prosper.com, an online firm that hooks up would-be borrowers with people looking to make an investment. Miller gave Prosper access to her credit report and wrote a short note for her Web profile explaining why she wanted the loan. Then over the course of seven days, lenders put forward funding bids (which can range from $50 to $25,000), with interest rates based on their assessment of Miller’s reliability. When the auction ended, Prosper picked the bids with the lowest interest rates, bundled them into one $3,000 loan and charged both Miller and her lenders a minimal one-time percentage fee.

Borrowers pay the loan back in regular monthly installments. If a repayment is missed, borrowers face the same penalties as if they skipped a payment on a bank loan: Their credit rating could be damaged, and the loan passed on to a collection agency.

Since its launch in early 2006, Prosper has won a queue of clients like Miller. Approximately 15,000 people have taken out a combined $92 million in loans. For borrowers, the site’s appeal is easy to understand, but why exactly are so many lenders rushing to sign up? It’s simple: Prosper allows them to take total control of their cash. Hand over money to a traditional bank and it’ll probably end up in an anonymous—and possibly unethical—fund. With Prosper, lenders make a profit, but they also help a real person with real dreams.

That bond between borrowers and lenders has created a strong sense of community at Prosper. Miller’s lenders—some of whom also work in the fashion industry—offered her contacts, plus advice on the day-to-day operation of her business. “Prosper is a useful networking tool,” she says. “I’ve learned a lot from my lenders.”

The banks’ loss has been a net gain for Prosper lenders. Miller paid off her $3,000 loan early, and eight months ago took out a $10,000 loan to develop a website (laramiller.net). Her once-local fashion brand is now sold in 24 stores across the U.S. At some point, Miller hopes to invest in Prosper herself, and offer another neglected entrepreneur a hand up. —Theunis Bates