Zopa is a company bringing borrowers and lenders in touch with each other, without the intermediary of a bank. It is a form of Social Lending.

Description

Contextual Citations

Zopa (Zone of Possible Agreement): the new company is an amalgam of a number of business philosophies. It is where eBay meets credit unions by way of easyJet, the peer-to-peer movement and Betfair. You can lend up to £25,000 through Zopa and your money is divided among 50 borrowers (who have already been screened to ensure they have good credit ratings) to minimise risks of default. (http://www.guardian.co.uk/economicdispatch/story/0,12498,1435623,00.html}

Citation:

"Here's the way the world works (and it must be right because it's been like this for hundreds of years...) People who have spare money give it to a bank. Banks then do whatever they like with it. Some of it they lend to people who need to borrow. Some of it they give to their shareholders. Some of it they gamble on the price of tin, or the dollar going down, or whether there'll be floods in Asia. Banks make lots of money from all this, a fraction of which they give back to their customers. Zopa though lets people who have spare money to lend it directly to people, like them, who want to borrow it. No bank in the middle, no huge overheads, no unethical investments. To minimise any risk, the money each lender puts in is spread amongst at least 50 borrowers (and likewise each borrower gets their money from a number of different lenders). Zopa is, therefore, for people who want to be a part of something new. Who want to join a community of like-minded individuals and lend to them and borrow from them in a trusting but secure way.

Zopa is for people who are looking for a better rate of return. Zopa's interest rates aren't squeezed by middlemen (the banks) because there are no middlemen - that's the Zopa idea.

Zopa is for creditworthy people who earn money in new ways, in ways that banks don't always recognise. People who are self employed, people who have peaks and troughs to their income, people who would be invisible to a bank's credit rating system but are seen and validated by Zopa's." (http://www.zopa.com/ZopaWeb/)

Profile

By Open Business at http://www.openbusiness.cc/2007/05/20/the-emergent-field-of-p2p-finance/

"Who: Zopa was set up by many of the team who launched Egg, and is backed by Benchmark Capital, (who backed eBay), Wellington Partners, Bessemer Venture Partners (the VC firm which backed Skype), Tim Draper and The Rowland Family.

Borrowers: People can borrow from £1000 to £15000 under contracts of £10 each, in multiples of £100. Borrowers must submit to being credit-checked by Equifax, and to having the results made publicly available on their profile. On the basis of this and other information collected during registration, they are assigned to one of four different markets (A*, A, B and C). In the less ‘credit-worthy’ markets, borrowers will pay significantly higher interest rates, to account for the statistically greater ‘bad debt’ rate. The ‘market rate’ for each of the four classes of borrower is determined globally and not on an individual basis. The funds are then reserved and after more checks with credit reference agencies the loan is approved by Zopa. The money is then paid directly into the borrower’s bank account, often within a few days. Any defaults or late payments will affect a borrower’s credit rating, as with a standard bank loan.

Lenders: Zopa lenders first transfer the amount they wish to lend into their Zopa holding account. This is a segregated account which is operated by Zopa and specified as containing money owned by Zopa members.

Zopa lenders can lend any amount from £10 to upwards of £25,000. Offers are made in amounts of £10 to each borrower, although the highest number of contracts any one borrower can have with a single lender as a result of his or her successful bids is 20. To lend more than £25,000 lenders need to first hold a Consumer Credit Licence. Lenders can choose their rates and loan lengths, and whether they want to lend in the A*, A, B or C markets. Zopa provide information - including market data and expected levels of bad debt - to help lenders choose their terms. Lenders will also earn 4.75% interest while they’re waiting for their money to be lent out. Zopa estimate that lenders should make a 6-7% return per year if all the money repaid is lent out again (an average bad debt of 4% is already taken into account). This is 1% to 2% higher than the current best savings account. Returns are approaching the level of long term stock market returns (which are around 8%) but are more predictable.

Community: Members who have not lent or borrowed with each other are only identified on the site by their nicknames. If you have lent money, you will find out the real names (but not any of their contact details) of your borrowers on the quarterly statement. If you have borrowed money, you will see the real names (but not any of the contact details) of your lenders on your loan contract note. There is not a great deal of engagement within Zopa on a community or social level, as the primary aim is to save lenders and borrowers money by ‘cutting out the middleman’, not to create a community of lenders and borrowers.

Typical transaction: Zopa is the most classical ‘financial instrument’ of the emergent P2P finance services, and the typical transactions reflect that: relatively anonymous, diversified holdings in widely ranging amounts.

Business model: Zopa makes money by charging lenders and borrowers a fee. It charges borrowers 0.5% of their loan amount and lenders a 0.5% annual service fee. It also earns money through selling payment protection insurance to borrowers who want it (they have a commission based deal with Pinnacle Insurance), and through introducing people who can’t pass Zopa’s credit checking regime to other loan providers (again on commission through ‘preferred’ suppliers). Zopa has received credit licenses from the Office of Fair Trading. It is authorised and regulated by the Financial Services Authority only in respect of its insurance mediation activities, although it must also comply with the “Higher Level Standards” that apply to all firms authorised and regulated by the FSA.

Establishing trust: Everyone looking to borrow is credit-checked and risk-assessed by Equifax, and people judged not credit-worthy will be prevented from borrowing at Zopa. The rest are put into either the A*, A, B or C market. This allows borrowers to “get a rate that’s right for them”, and means lenders can manage their risk level. Lenders are encouraged to diversify risk by spreading money across a range of borrowers. When a person lends £500 or more, her money is spread across at least 50 borrowers. A collections agency chases missed payments on each lender’s behalf. Zopa’s model is close to that used by banks and other financial institutions. In the event of a total business failure, the loan agreements still stand because Zopa is not a party to any loan contracts; it only provides the mechanism for agreeing them. The repayments will continue to be collected by a collections agency that is appointed by Zopa lenders to collect missed payments. The costs of collections activity will not vary if Zopa has failed. Zopa also have a number of online and offline procedures to catch unusual or suspicious behaviour on the site and can immediately suspend the membership of anyone whose intentions do not look completely honourable. These procedures are not elaborated.

Performance: Zopa has been relatively successful, and has recently secured an additional $12.9m of investment to expand its business in the UK and to launch in the US.

Problems or limitations: The forced diversification and lack of meaningful contact between lender and borrower may mean that users could feel somewhat estranged from one another. Lenders know the ‘class’ of borrower (e.g. A*, B) but they cannot lend more than £200 to any one borrower. The bond is ultimately legal and not social — the devices for reclaiming money are drawn from the banking industry, such as risk evaluation and collection agencies. The potential social aspects of the service are not exploited to the same extent as they are in competing services (such as Prosper) since personal interaction is not of great importance to the model." (http://www.openbusiness.cc/2007/05/20/the-emergent-field-of-p2p-finance/)

Discussion

Risk-Mitigating Strategies at Zopa

"Zopa is a peer-to-peer banking service, and a powerful example of a business model that works for all three parties. In essence, it turns each lender into a banker. Lenders' money is ascribed to specific borrowers, and is at risk if those borrowers default on loans. While it's not possible to rely purely on goodwill to avoid this happening, Zopa has found a system that minimises the risk, as its co-founder and CEO Giles Andrews explains:

"We'd observed that big companies tended to get a much better deal out of financial services than individuals did, because of the bond market [which connects big investors and borrowers directly]. One of the requirements for such a marketplace to function is trusted third-party data. Rating agencies provided really good quality information on companies. They haven't done quite so well in rating mortgage securities but they've always done quite well on companies.

"So we asked ourselves, could you imagine a scenario where there was a similar marketplace where consumers went to get a loan, and is there any data that's useful? And the answer was yes. It's quite different data – the credit bureau data on individuals isn't as predictive on an individual basis as Moody's rating of General Electric, but on a portfolio basis it works extremely well. As long as you're lending to lots of different people, the data works just fine – it's highly predictive."

So while lending £10,000 to an individual might be a gamble, lending £10 to 1,000 individuals makes the risk much more quantifiable. Because Zopa connects its borrowers and lenders directly, it can offer both parties some excellent interest rates, typically at around 8% APR for a £5,000 loan or investment over three years. Borrowers pay a one-off £100 fee to Zopa, while lenders pay a 1% annual service fee. Some people will always struggle to repay loans, but because each lender typically only lends £10 to each individual borrower, the risk is spread across multiple lenders.

Zopa also minimises defaults by only offering loans to people with excellent credit ratings. "We've had bad debts of less than 0.9% in the six years since we launched, which is way less than any other lender," says Andrews. "Part of it is because I think we built a better system, but another part of it is that people know they're borrowing money from real people and don't want to let them down."

Of course, that could change in future, and it's also possible that Zopa could cease trading – don't expect any bank bail-outs here. However, loan repayments would still be payable as the contracts are with lenders and borrowers directly. An FAQ page (http://tinyurl.com/zopafail) explains how this would be carried out in practice.

Andrews told us how an early inspiration for Zopa was the phenomenal rise of eBay. "There was something slightly anti-establishment about it, bypassing big institutions or big retailers. Something about people power, and something about the power of trust. However, we couldn't replicate an eBay behaviour model because, actually, it's not a great idea to lend money to borrowers on a regular basis; it tends to suggest that they can't afford it.

"We did run [a system where lenders picked individual borrowers] for a little while – a sort of eBay-type listing model where people put up their picture and said what they wanted to borrow the money for. It provided a bit of colour for the website, but we found that adding the emotional cues tended to reduce the efficiency of the transaction. While they might quite like the process, they ended up making worse decisions than if they didn't know that stuff. That was particularly the case [for other peer-to-peer lending services] in the United States where you have lots of pictures of attractive young women looking for loans for really worthy family purposes, unfortunately a disproportionate number of whom went on to default." (http://www.expertreviews.co.uk/general/1290001/peer-to-peer-living-save-money-by-cutting-out-the-middle-man/)

More Information

A successful German lending and borrowing experiment, dieborger.de, at http://theage.com.au/articles/2005/03/17/1110913726676.html?oneclick=true

Other Peer to Peer Exchanges and Social Lending, are described here at http://www.wired.com/news/culture/0,1284,66800,00.html

Zopa

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