Loan ranger

By Julian Rogers

Peer-to-peer lending website Zopa provides a platform to bring lenders and borrowers together, bypassing the banks. Five years after its emergence, CEO and co-founder Giles Andrews says the public’s distrust of the greedy banks has been a boon for his business.

“The riskier groups pay higher interest rates to the lenders but the default rate will be higher.”
- Giles Andrews

When I was a kid I loved the board game Monopoly. Unfortunately I was always bereft of that ruthless property developer streak required to win. I would invariably end up lumbered with a couple of train stations, the deeds to the water works and a few cheap houses dotted around Old Kent Road and Bow Street. After a couple of involuntary nights spent in swanky hotels on Bond Street and Park Lane I was usually re-mortgaged up to my neck and limping around the board praying for the dice gods to prevent my battleship counter from landing me in yet more financial misery. Even being sent to jail looked inviting at this stage of proceedings; you can't get issued with inexplicable income tax bills or mysterious parking fines when you're banged up, right?

Suddenly, a devious grim would creep across my brother's face before he threw me a financial lifeline: a UK£2000 loan with an exorbitant interest rate of 50 percent - sometimes higher - to be repaid within the next two laps of the board. Drowning in a sea of debt and ignoring the small print, I would reluctantly accept his offer just to get my desperate mitts on four red £500 notes. But this futile bid to keep my head above water and stay in the game meant I was always headed for one place: bankruptcy.

Sidestepping the banker and obtaining a loan from a fellow player is pretty much how Zopa works, sans the crippling interest rates. Zopa, an acronym of Zone of Possible Agreement, is a so-called social lending site that acts as a middleman between individuals looking to lend money and those seeking a loan, 24 hours a day. The business was co-founded by Giles Andrews, who led four fund raisings for US$35 million from US and European investors before Zopa burst on to the world wide web in 2005. The business model was based loosely on online auction site eBay and internet betting exchange Betfair, the underlying factor being that these sites also take a commission for bringing two people together in a transaction over the net. Zopa says social lending is a "smarter, fairer and more human way" of lending. An average of UK£4 million in loans is agreed every month. "People really like working together and have convinced themselves that together they can get themselves a better deal than by dealing with more traditional institutions," Andrews explains. It's a business model that is outshining the banks, according to Andrews. "Our loan book has performed better than any of the UK banks consistently from the day we'd launched till now - we've got default rates they would only dream about."

Borrowers typically borrow around UK£5,000 (the minimum permitted is UK£1000 and the maximum UK£15,000), which is usually put towards a new car or making home improvements, says Zopa. On the other side of the fence, lenders achieve an average return of 8.2 percent. The average lent is UK£2000 but this doesn't paint a true picture according to Andrews. "It's misleading because we have people lending as little as UK£10 and we have people lending many hundreds of thousands of pounds." Zopa charges a one percent service fee to lenders while borrowers pay UK£124.50 on a loan. So what's to stop an unscrupulous borrower from running off with my cash, I hear you cry? Well, if you lend UK£500 or more then your money is spread across at least 50 borrowers and the average default rate is 0.7 percent. "I probably wouldn't choose to lend 10 grand to a complete stranger in the pub on the basis of his credit file," says Andrews, "but I might happily lend 10 quid to 1000 people who share the same credit profile."

Checks are made to vet potential borrowers and those accepted are put into categories according to their ability to pay - A* (super clean borrowers) down to much riskier borrowers in band C. There is also a Y group made up of young borrowers. Lenders then make offers, such as wishing to lend x amount of cash to an A-rated borrower for x period and with x amount of interest. The A-rated borrowers then choose whether or not to accept the lenders' money. If a borrower does default, they are chased for the debt through proper legal channels. The riskier groups pay higher interest rates to the lenders but the default rate will be higher. It's a case of balancing risk versus reward when loaning out your hard-earned cash.

Crunch time

In the last two or three years, Zopa's growth in popularity has reflected the groundswell of distrust of the banks among the public. The credit crisis was sparked by reckless practices by the loosely regulated banks, which snowballed into the worst recession since the Great Depression. Such is the distrust of the banks' nowadays that owning up to plying your trade as wheeler-dealer hotshot in the City carries about the same stigma as admitting to being a war criminal. Zopa benefited from the banks fall from grace, Andrews reveals. "We were three and a bit years old when the credit crisis hit and had been working really hard at building up trust in the business. Consumers didn't feel they were getting a good deal out of banks - there wasn't the same degree of banker bashing as there is today, but there certainly was an appetite to look at alternatives." Andrews says Zopa's loan book has been properly managed. "We could say we had managed credit properly while all these banks were losing a fortune making stupid lending decisions."

Unlike some of the banks, Zopa took a cautious approach to acquiring borrowers rather than rushing in gung-ho and accepting those with even the most patchy credit histories. "We could have taken much more risk. We could have lent more unwisely and we could have grown our business faster by accepting more of our applicants. We could have pitched the business at more risky consumer groups where the rates of return might have looked more exciting, so that subprime lenders made returns in the high teens compared to prime lenders making returns of eight or nine percent. But had we done any of those things then we wouldn't necessarily have been able to get the money back to our lenders and I suspect we wouldn't be here."

While the banks get involved in everything from mortgages to betting on the price of aluminium, Zopa's business model is focused on unadulterated lending. Andrews says both parties on either side of the deal like the simplicity of it all. Alongside the knowledge that their money is helping real people, lenders particularly appreciate the returns available from Zopa, far outstripping current savings rates. UK savers have had a bum deal since rates were slashed by the Bank of England from five percent to a pitiful 0.5 percent in order to kick-start the fragile economy. Zopa's eye-catching returns have tempted plenty out-of-pocket savers to become anonymous lenders through Zopa. "Savers in the UK are being hit where it hurts very hard," says Andrews. "People who depend on savings for an income, like retirees, are in real trouble and desperately looking for alternatives to get a better return." Likewise, the banks have been reluctant to lend to customers, so have hiked up their interest rates. It's been a win-win situation for Zopa.

Back in 2005, Zopa's founders made a conscious decision not to throw money at aggressive marketing campaigns, choosing instead to let the company grow through word of mouth, and its uniqueness generate its own publicity. The day of Zopa's launch saw the site reported in London's respected Financlal Times newspaper and The Economist as well as a clutch of other print and web publications. The media's inquisitiveness about the business still exists today, which is reflected by a media section on the Zopa website stuffed with press cuttings and TV and radio clips. As of August of this year alone, Zopa has been covered by 45 media outlets. "We're terribly lucky that the story remains interesting," the boss notes. After the launch, Zopa created a stir, particularly among techies and IT professionals who were au fait with groundbreaking internet start-ups. "Our early adopters were heavily dominated by IT professionals and a few people who worked in the City. With any new products like this, the IT boys like to have a look around and talk to each other, because they are interested in technology."

Nowadays, Zopa's customers come from all walks of life, although the majority tend to be men, especially the lenders, who are often middle-aged or retired men with disposable incomes. "It's probably fair to say that our very big lenders are typically older and either in or approaching retirement," Andrews reveals. "However, we've also got lots of young people lending very small amounts of money, presumably because they think it's interesting."

Zopa also strives to generate an online community so that users get to interact with one another and discuss the business of lending and borrowing.

Its online forum, for instance, is especially handy for those getting to grips with the ins and outs of the site. "We're very lucky that we've got a group of users who are prepared to give up their time and knowledge to help educate new people." There is also a healthy following on the company's blog, Facebook and Twitter - the latter being a convenient platform to answering users' queries. "We find that if customers tweet us with a question it tends to get answered very quickly indeed compared to email. So it's just a very efficient way of dealing with people. The customers like it and the people here like it."

Market forces

Zopa's success in the UK led to Andrews and his team eyeing up the almost endless opportunities that lay overseas. However, it wasn't as simple as just setting up shop in a foreign country and then counting the cash as the punters came flooding to the site. Markets like the US offer "huge potential" according to Andrews, but regulations vary greatly across the world and ultimately proved to be a thorn in the company's side. "The regulatory challenges are enormous in every country - it's not like eBay, which is easy to roll out from one country to another." Zopa launched in the US in 2008 but regulatory pressures meant the business was different to its UK counterpart. "We ended up launching a business in conjunction with credit unions, which are a rather bigger group in the United States than they are here. It wasn't as strong a peer-to-peer business model as it is here, and we also launched in 2008 right in the face of global Armageddon."

After a year, the decision was taken to withdraw from the US. Efforts to break into Japan ran into difficulties and in Italy Zopa was forced to operate through a franchise. "It's absolutely not trivial to launch in different countries and indeed in some countries it's not even possible." Andrews describes the company's retreat from the US, the biggest market in the world, as "painful" but is focused on the UK for the time being. "We'll confine our ambitions to the UK for a year or two and see how we get on, because the UK is a big enough place for us to build a substantial and exciting business and then maybe think again internationally."

With Zopa garnering increasing attention and other peer-to-peer lenders such as YES-secure in the UK, Smarva in Germany and Boober in Holland, does Andrews believe traditional bricks-and-mortar banks and other financial institutions should be quaking in their suits? "I think we definitely represent an enormous threat to them in this segment of the business because we do it more efficiently," he states confidently. "So yes, they should definitely be worried, but if we and other person-to-person lenders were to take half of the banks' personal loan business away from them in the next five years, then that represents an enormous opportunity for us but it's not a terrifying loss for the banks because they do so much else. So we could take a very a profitable niche away from them, and it might impact share price a bit but it's not going to kill them."