PhotoEarlier this week we told you about how “new technology threatens old banking institutions,” at least according to a new marketing survey suggesting that, compared to older Americans, those younger than 34 are far more willing to consider getting their banking needs from sources other than traditional brick-and-mortar banks.

One of those non-traditional banking possibilities is peer-to-peer lending. It's not exactly a new phenomenon – in 2011, we gave advice for potential borrowers seeking a would-be loan through peer-to-peer sources – but at some point in the past year or so, it morphed from “the latest Internet niche product” to a major player in the financial landscape. Last year, for example, Google bought a stake in the peer-to-peer Lending Club.

What it is

What is peer-to-peer lending? As the name suggests, it's lending done mostly between individuals (peers) — you borrow money from an individual lender (or a group of individual lenders) as opposed to borrowing from GigantoBankCorp. Or, on the other side, you lend money as an individual investor, rather than as part of GigantoBankCorp.

The benefit is that, obviously, you're not dealing with GigantoBankCorp either way, so lenders and borrowers both can enjoy more flexibility than huge and highly regulated financial institutions generally allow.

The downside is also that you're not dealing with GigantoBankCorp, which for all its institutional flaws still enjoys benefits like FDIC insurance coverage — and the inertia left over from generations of people raised to associate “banking” with GigantoBankCorp rather than, say, some lender on the Internet.

Of course, that inertia might be fading as more people every year become adults whose entire childhoods were spent taking the Internet for granted.

Investors becoming interested

Recently, there's been a rise in news reports about peer-to-peer lending – not from a borrower's perspective, but from an investor's. (Overall opinion: investing your money in P2P lending is probably riskier than investing it in old-school banks — but the potential returns are a lot higher, too.)

On May 8, for example, the Economist ran a story about the role P2P lending plays, especially in the modern Chinese economy (where American-style banking regulations and property rights are nonexistent, of course): headline “We try harder” and subheading “Without the banks' baggage, shadow banks find it easier to oblige customers.” (That “baggage” includes such obvious things as the cost of building and maintaining actual physical bank branches, as opposed to P2P lending which requires little more than a reliable, secure Internet connections.)

On the other hand, traditional-banking advocates say the main reason P2P lending is so popular among investors right now is because interest rates remain unusually low by historical standards. As the Economist noted:

bankers often express scepticism about P2P’s staying power. As volumes grow, they say, underwriting standards are bound to fall. Investors will have no real sense of the risks they are running until the next downturn arrives. Moreover, the model’s appeal relies partly on the current low interest rates around the world, which make the extra yield from P2P especially alluring to investors. When rates begin to rise again, that advantage will dissipate.

What is the yield from P2P, anyway? Lending (obviously promoting a pro-P2P point of view) asked this last September:

what return does peer to peer lending even offer?

It is this last question that we will devote the focus of our article today, hoping to get an answer by turning to leading voices within the industry. Interestingly, their answers widely vary. Some think a 5% return can be expected; others say 12%.

Twelve percent return on a non-loan-shark lending investment sounds too good to be true, or at least too good to be reliably counted upon. Five percent, on the other hand, sounds reasonable, and certainly better than the 1 percent or less interest rate banks give on savings now.

However, it was less than a generation ago that four or five percent was a standard, unremarkable interest rate of return for just a regular FDIC-insured savings account; only in this era of unusually low interest rates would any investor seriously consider putting money in a risky investment in hope of a mere five percent return.

So those banking advocates mentioned in the Economist, the ones who say P2P's investment advantages will disappear once interest rates return to historically normal levels, might very well be correct.

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