Reciprocity banking



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Posted by: stak
Tags: reciprocity
Posted on: 2012-05-26 09:37:39

Scott Adams had a post yesterday called No Banks on Mars. It was kind of interesting to me, since I've been thinking about the banking industry in general recently. I mostly agree with what he's saying, but think that there's an alternate system that could exist alongside traditional banks. He's right in that the loan business is where banks make their money - they're basically a middleman between people making deposits and people getting loans. And they make billions of dollars doing it. What if we could eliminate that middleman and use the Internet instead?

What I'm thinking is that the loan side of banks can fundamentally be replaced with a peer-to-peer crowdfunding site. This website would have a set of properties:
(1) allow anybody anywhere to participate as both lenders and borrowsers
(2) allow borrowers to specify how much interest they are willing to pay on their loan
(3) allow lenders to fund partial loans

All of these properties exist on various microfinance websites today, but I haven't found one that does all of them together. See for example Kiva, Amifi, Prosper, Zidisha and so on.

Right now I think Zidisha is the closest to what I'm thinking, because they follow (2) and (3) without using any intermediate agencies. However they don't let just anybody sign up and ask for loans, they're focusing specifically on borrowers in Kenya, and are still somewhat playing the "it's cool to help out developing nations" angle. From a financial point of view that angle is irrelevant, though, and it's still a reasonable way to make for lenders to make a decent return on their investment.

Prosper.com is also good, and is one of the ones that takes out the "help developing nations" part of it, and just has the peer-to-peer crowdlending stuff. Unfortunately it's only restricted to the US right now, as far as I can tell, so I haven't been able to try it out.

Websites like these are already great because they allow borrowers to get loans that they wouldn't otherwise be able to get, or at lower rates. They also allow lenders to earn higher interest rates on their investment, and allows them to diversity their investment portfolio much more (i.e. imagine lending $50 to 100 people each instead of having to sink it in some mutual fund which may or may not make money). Everybody wins.

What of fraud, you ask? People could sign up as borrowers and then just run off the with money. With a bank at least you're insured against that, you say. This is the trickiest part of it, I think, but this problem can be mostly solved by having reputations assigned to people. If they repay their loans on time then their reputation goes up. If you don't want to make a risky loan, then don't lend money to somebody with a low reputation. There are other approaches that could be borrowed from other fields and applied here too. I bet eBay has a lot of fraud detection heuristics and algorithms that could be adapted to this purpose. I'm sure there are other techniques as well that are more in line with the idea of a reciprocity network.

Posted by Varun at 2012-05-27 19:13:44
Wait, what's the difference between your proposal and a stock exchange, other than the venue and scale? You can participate as a lender (investor) or borrower (firm), specify interest as a borrower (dividends), and fund partially (carry a certain number of shares, in combination with other investors). When Google did its IPO, it did a couple of interesting things on the structuring size that reduced the payout to middlemen, so you may want to read about that.

Additionally, you're right to identify fraud as an issue, but really it's a specific form of risk carrying capacity. Most of the general population is exceedingly risk-averse, which suggests to me that you'd either need to develop a mechanism to cope with the risk (in eBay's case, several percent of the final item price), limit the overall exposure of the population (thereby limiting the total loan size), or accept few people will participate as lenders (limiting the size of your total investment pool). I think it's true that as eBay has matured, fewer new people are getting on the site, because it's too hard to establish a reputation and sell the item: buyers are too wary of newly established sellers to buy anything from said new-comers (which becomes itself a new type of cost).

On the other hand, I think it's worth a shot. Kickstarter for the loan business. :)

And if I were setting up shop on Mars, I like Robinson's cooperative system for firms. Wouldn't mind seeing it happen!
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Posted by stak at 2012-05-29 18:47:50
A stock exchange is actually pretty similar, now that I think about it. But I think as currently implemented there are still some significant differences. For instance it's not easy for individuals to sign up as borrowers, and in the common case there isn't a clear timeline and interest specified to lenders. With some tweaking it would be pretty close though.
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