Jim from NetBanker is quoted in this quite comprehensive article on Prosper with real customer examples provided.

When you have a brand-new ecosystem like this, you don’t know how much fraud can come into play,” said Jim Bruene, editor of Online Banking Report.

Source: Want to Loan Me Money? Here’s a Picture of My Dog. – washingtonpost.com

The fraud aspect is outstanding, and the other thing I felt the article didn’t really get into is the social aspect.

Lenders are encouraged to protect themselves by lending small amounts to many borrowers with different risk levels so if one defaults, the lender is not as seriously harmed financially.

Though some borrowers pay interest rates upwards of 20 percent, the loans can still be cheaper than other forms of credit, such as a payday loan which can carry a triple-digit annual interest rate.

The mechanics are explained well.

Prosper verifies a potential borrower’s identity using his name, address, date of birth and Social Security number. The company also pulls the applicant’s credit report to create a “credit grade” ranging from AA to HR (for high risk). The grade is included in the listing, along with any state interest rate limits. Virginia borrowers, for example, can’t be charged more than 12 percent interest except by a chartered bank like Citibank. Prospective lenders then bid to fund the loan.

Lenders, who can finance small pieces of many loans, get a chance to earn higher returns than they might find elsewhere, but it’s not simply a numbers game. They get a borrower’s story, how much money they want to borrow, the interest rate they’re willing to pay, and the reason they need the money, along with monthly income and expenses. Often, pictures of borrowers, their dog or their children accompany the pitch.

Once a loan is funded, Prosper charges borrowers a 1 percent origination fee, and charges lenders an annual fee of 0.5 percent to service the loans. It automatically withdraws payments from borrowers’ bank accounts and sends them to lenders. It also deals with defaults. It charges late fees. Any loans that are 30 days late go to a collection agency. Debts at least four months past due are sold to debt buyers.

No doubt there will be some fraud.  I see two types broadly:

1. borrower fraud, with individuals attempting to get a loan using fake or stolen identification
2. organised crime who will sell baskets of stolen id’s to organised crime distribution groups (pharmers)

These will generally be caught using traditional credit procedures, and other associated techniques that will ensure the borrower is the person claiming to be the borrower.  I won’t get into what those other techniques could be, but they will be essential.   This will potentially also require multi-factor authentication, additional measures, such as PassMark or RSA to be implemented to protect from account takeovers.