This is something I have been meaning to blog about for a while, and of course, waiting has meant that others have beat me to it. The internet has spawned a number of Peer-to-Peer (P2P) lending sites. These sites borrow a page from the microfinance organizations in developing countries that have moved onto the internet. For example, sites like Kiva where individuals can lend to fund small entrepreneurial projects by individuals in developing countries. Savers can act directly as lenders without any financial intermediary. This is a hard thing to do in general, because it is hard to find people and projects to lend to. There are also problems of asymmetric information (borrowers know more about their probability of default than do lenders) and moral hazard (borrowers have an incentive to be more risky when it is someone else's money). Financial intermediaries (like banks) can overcome these problems through access to lots of borrowers through retail outlets and the like, numerous resources to get information about the borrowers (credit scores, work history, etc.) and through the diversification of risk so that the money they accept on deposit is almost completely safe (and definitely so with FDIC insurance).
But now there is another way for savers to earn interest on their money and a way that while involving more risk, earn higher returns as well. P2P tries to get around the problems by being on the internet for one, which is a remarkable tool to reach millions of people, requiring information about borrowers, and keeping track of repayment histories. There is a serious problem of adverse selection however. The people who go to P2P lending sites are probably disproportionately people who cannot get access to mainstream credit and many of these are people who cannot due to poor credit scores from a history of repayment issues. So though they try to tackle the problems, their ability to do so is limited. The loans are also generally small personal ones, insufficient for businesses and big personal needs like home loans.
Thus, though P2P is another great market that has sprung up due to a unfulfilled need, I don't think it will supplant mainstream banks anytime soon.