Early results are promising, but whether the peer-to-peer lending models of online operators Zopa and Prosper can entice the risk-averse masses away from banks remains to be seen. Karina Robinson reports.

Tara Basri, a 53-year-old London-based technology consultant, puts money into bonds and shares, among other investments. He has also, from late 2005, put his money to work through Zopa, an online lending exchange founded earlier that year. He is currently lending £150,000 (€220,000).

“It changed my bank’s life. I left!” he exclaims. Mr Basri used to have accounts at Dutch bank ING, among others.

Rather like online auction market eBay, UK-based Zopa (which stands for ‘zone of possible agreement’, the area between two parties where an agreement can be reached) and its US counterpart Prosper represent the phenomenon of internet-savvy people who want to dispense with established intermediaries and their fees and like the idea of being part of a new community.

A threat to banks

Parveen Bansal, senior research analyst at Financial Insights, a technology consultancy for the financial services industry, believes online lending exchanges are a threat to established banks, even though they are still a very small part of the market, because they represent disintermediation in action.

“Online lending exchanges are mainly attractive for those people with the time and knowledge to manage their own portfolios of investment. They are not so much a direct threat to banks, as they are an opportunity to take control of one’s banking. A high rate of return, an easier borrowing process and flexibility are areas where the established banks cannot easily compete due to their size,” she says.

Ms Bansal does not think these peer-to-peer exchanges threaten the existence of banks, but they may take away a chunk of the high net worth customer group as well as reduce their personal loan market.

Online exchanges reportedly also represent the new phenomenon of social lending – seeing where your money goes. For instance, a man who calls himself ‘TimmyMO’, based in Durham, North Carolina, has his photo on the Prosper website. He writes in moving detail about his circumstances, his wife’s illness and his work in the automotive industry. He needs $2000 (€1500). So far, the website shows, 23% of his loan has been financed by various lenders at an annual percentage rate of 15.89%. That is a level of transparency not available from banks.

However, the tie between lenders and borrowers can be rather tenuous when, to minimise risk and bad debts, an exchange like Zopa, which prides itself on a default rate of less than 0.2%, automatically divides the loans for lenders. Mr Basri’s loans on Zopa are divided among more than 4000 borrowers.

Credit checks

Zopa and Prosper have slightly different models. Among these differences, for instance, the former verifies employment details, the latter does not. As a result, Ms Basri is content with his return of close to 8%, while lenders on Prosper can expect a higher return to cover them for higher bad debts.

In addition, Zopa has eschewed lending to consumers with patchy credit records, unlike Prosper. As a result, Zopa had to turn away all prospective clients in its first three months, says co-founder James Alexander. The aim was to create a reputable exchange – despite not being a bank with substantial capital behind it – in order to grow.

“The thing that is making a difference is trust. Up to 50% of our lenders have topped up their accounts,” says Mr Alexander. There are now 120,000 members and the average borrowing is £5000. Zopa has 35 employees in the UK and a small team in the US, although this is expected to increase on the back of its launching there later this year.

Despite being web-based, regulation means lenders and borrowers must live in the country of the exchange – however, as regulation develops, it looks likely that this will change and online lending will eventually be done internationally.

In the meantime, Zopa is exploring other international markets and was set to open in Italy as The Banker went to press. It will make a good starting point. Zopa should receive a warm welcome in a country where a basic bank account costs each client an average of e182 a year, much more than in other European countries, according to a report published earlier this year by Italy’s Antitrust Authority.

Franchise possibilities

Zopa is also looking at franchising its model. Mr Alexander says that franchisees might be interested in its proven technology platform, its brand value and its experience in starting from scratch.

Which model of online exchange might predominate in the world – Zopa’s, Prosper’s, or one that has yet to be invented – is not yet obvious. But what the existing ones share is offering better rates to lenders and borrowers than banks, according to sources such

as moneysupermarket.com, a price comparison website. This is possible because they do not have the bank burden of heavy cost bases and capital requirements.

Zopa makes money by charging borrowers a 0.5% arrangement fee while receiving from lenders a margin of 0.5% a year on the loan made. It also makes a commission from selling payment protection insurance (PPI) and a commission from sub-prime lenders to whom it sends people whose credit history is too risky. It outsources payments, technology and bad debt collection to keep its costs down.

Backed by a few private equity firms, Zopa expects to break even this year and become profitable next year.

“The real risk for Zopa’s credibility is that bad debts start to rise to levels which scare lenders away. At the moment bad debt is at tiny levels,” says Ms Bansal.

Potential negatives

Benjamin Essor, senior analyst at market research company Forrester Research, looked at other potential negatives in a report last year. He noted that the number of sophisticated financial investors is small, that introductory offers which included waiving fees overstate Zopa’s success in attracting users and that consumers are notoriously risk-averse investors, which may mean attracting enough lenders proves difficult.

Another risk is that Zopa, or Prosper, do not manage to gather sufficient liquidity. As a marketplace, they need buyers and sellers, and the more of these, the better the offering. eBay, for instance, took four years to become the dominant player. However, that does not mean another player might not come in and become number one.

“I don’t know whether banks should be worried about Zopa,” says Mr Alexander, “but [they should] be about the model, because it is sound and efficient.”James Alexander: Zopa co-founder

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