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TechvisionDecember 1 2014

Why Zopa scores highly in the rating game

The credit rating capabilities of peer-to-peer lending platform Zopa has proved to be more effective than those in many banks. Giles Andrews, the company's CEO, explains how the company has honed such technology and discusses the possibility of outsourcing it to banks.
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Why Zopa scores highly in the rating game

The problem with credit scoring is that it takes a while to know if the models are correct. Loans can be made, but it is not until they are repaid in full that lenders can breathe a sigh of relief. For start-up lending platforms – which, unlike banks, do not have masses of data on existing customers to analyse – it can take years for the benefits of good risk performance to show themselves.

At Zopa, the peer-to-peer (P2P) lending platform that was launched in the UK in 2005, the results of its credit scoring model now speak for themselves.

Giles Andrews, Zopa’s CEO and co-founder, like many entrepreneurs in the financial technology space, sees technology as an enabler and not an end in itself. He attributes Zopa’s success to its business model – it provides a platform for borrowers and lenders to meet – rather than the technology. Zopa does not lend its own money and acts much like a bond market for individuals. The borrowers are vetted and approved by Zopa, and lenders come to the website to get a better return than they would expect from a bank savings account. The lenders’ money is spread across a number of different borrowers, who are grouped according to the term of the loan.

The long-term success of such a model hinges on its credit scoring capabilities. “We execute that business model using more state-of-the-art technology; we can adapt quicker and move in a more agile fashion [than banks],” says Mr Andrews.

Low default rates

Unlike banks, Zopa is not burdened with legacy systems. “Part of the execution of the business model is that we happen to have the best performing risk function in the UK, if not the world,” he says. This may sound like a bold claim, but so far Zopa’s default rates have been lower than banks, and also other P2P lenders.

In 2013, for example, the default rate was 0.34% of all loans, which compares favourably with the 1.41% that Zopa was expecting. Mr Andrews attributes this to the sophisticated data analytics as well as the broad and varied sources of data Zopa uses to assess its borrowers.

If Zopa’s analytics tools are so good, does this mean Zopa could set up a separate technology company to white label and outsource its capabilities? “Would we ever consider it? I suppose we would,” says Mr Andrews. He adds that he was approached by a bank – through a consultant – that was interested in using Zopa’s data analytics tools, but he says he “politely declined” the offer.

Zopa’s analysts are already very busy and “they are better employed at improving our products and our own analytics”, rather than working with other providers. The analytics is “an important source of competitive advantage. It is more a function of the priority we give it in investment, relative to the size of the business, that is critical rather than the technology,” says Mr Andrews.

The right kind of people

Part of that investment means investing in the right talent, and Zopa has analysts who have previously worked at Amazon, National Aeronautics and Space Administration and CERN. “Really smart analysts do not tend to work in banks,” quips Mr Andrews.

Banks remain Zopa’s biggest competitor, even though the P2P lending industry has grown, with the emergence of several other players, since Zopa’s launch. As one of the founding fathers of the P2P lending industry, Mr Andrews points to the downsides of being an early mover. “When you’re all alone in a sector, consumers might think it is a bit weird and think ‘if it is such a good idea why are you the only ones doing it?’,” he says. Now in the UK there are other entrants, such as RateSetter, Funding Circle and LendInvest, which are members of the industry body Peer-to-Peer Finance Association.

Mr Andrews notes that this association has been an effective vehicle for lobbying for change, such as campaigning for the P2P industry to be regulated. In October 2013, the UK's Financial Conduct Authority (FCA) outlined how it would regulate crowdfunding – which includes P2P lending and equity investment-based crowdfunding – and, from April this year, the FCA began regulating the industry. Mr Andrews says that he wanted the industry to be regulated for two reasons: to protect consumers and also because by being involved at an early stage, the industry could shape the regulation rather than having inappropriate rules imposed on them at a later date.

When asked what the future holds, Mr Andrews notes that one of the challenges for Zopa is to ensure that the quality of lending is maintained. For now, the P2P lending industry is growing, but one danger is that in pushing for further growth, credit risk assessment can slacken – the results of which can take years to manifest themselves. Mr Andrews, however, is not worried – or no more worried than is healthy for a CEO of a P2P platform – and expects Zopa’s strong performance to continue.

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