Lending website banks on the eBay generation

Zopa allows internet users to bypass the major financial institutions and buy and sell loans to one another, writes Robin O'Brien Lynch.

During a World Cup first round match this week, a soccer fan caught an official match ball booted into the crowd. As the camera zoomed in on the delighted fan clutching his prize, the commentator remarked that the ball would soon appear on "that website where you buy things".

Assuming he was referring to eBay, this episode highlights just how much the concept of the auction website has invaded our consciousness (the name still appears to cause some people trouble though). It is in this global climate that Zopa.com - an online service that allows people to buy and sell loans from and to each other, rather than the bank - has been slowly gathering pace.

The service works as you would expect: borrowers request loans online, and lenders agree to give them the money for a certain return. However, to minimise the risk of default, Zopa divides the lenders' money into small amounts and distributes it to potential borrowers.

All lenders and borrowers enter into a legally binding contract with their respective borrowers and lenders. The UK-based firm manages the collection of monthly repayments and if any of that money is not paid on time, it uses the same recovery processes as the high-street banks.

Zopa earns money by charging lenders and borrowers a 0.5 per cent fee, and if borrowers take out repayment protection insurance on their loan, it receives commission from its insurance provider.

So far, there are more than 77,000 members. Average gross returns to lenders since the launch has been 6.8 per cent and, in some markets, over 10 per cent, while bad debt levels remain less than 0.05 per cent. Zopa has also topped consumer watchdog lists for best buys.

Lenders can loan as little as £10 (€14.63) over a period of six months to five years, and from the beginning of next month, there is no maximum limit on the amount being loaned. Money is transferred into the lending account either by a regular bank transfer, or by PayPal. Borrowers pay off their loans by the same method or with direct debit, and there is no charge for early repayments.

The tone of the Zopa site is the same light-hearted, personal tone found on other peer-to-peer sites such as Flickr. This taps into the public perception that the service offered by high-street banks is artificially personal, impersonal or rude.

Zopa positions itself as an institution for the modern age. It utilises the social community aspects of the web that have proved so successful for internet giants such as Bebo, Amazon, eBay and Betfair.

And like any good web community, Zopa users are known only by their anonymous user names, eg warlock3000, kroonmeister and spiderwoman. There is a monthly newsletter, discussion forums and a blog.

But the "team" - not the "board of directors" or "management" - is keen to back up the jaunty graphics and jokey content with serious credentials. Zopa has its own credit referencing system, is authorised and regulated by the UK financial services authority and is backed by venture capital firms Benchmark Capital (which backed eBay's launch and has taken a stake in Bebo) and Wellington Partners. Even the term Zopa has the advantage of both sounding likea fresh, edgy brand name as well as being a financial acronym for '"zone of possible agreement'", the bounds within which both lender and borrower are prepared to work.

Immediately after its launch in the UK, Zopa was applauded for its ingenuity and even bravery, but many commentators felt that it was a bridge too far and doubted its longevity. However, 18 months later the model continues to function, and co-founder James Alexander believes Zopa is now in a position to prove the doubters wrong.

"We launched in the UK in the middle of March last year. It's a new model and people are still getting comfortable with the idea," he says.

"At the time of the launch, the press coverage was very much: 'Well, this is a great idea and all, but we'll have to wait and see'. At this stage, a year and a bit later, we're still here and we're doing well and we're in a position where we can share information. We can say why people are using it, we can say how people are using it, we can say what the default rates are and so on."

He continues: "It started when three people left the online bank Egg to start a business. We had no real specific idea, but we had done a lot of consumer work and the idea for Zopa began to grow.

"Firstly, we wondered why doesn't eBay do money? Instead of buying and selling stuff, it could buy and sell money. Secondly, why do companies borrow money at lower rates than consumers? Around 200 years ago, if a company wanted to borrow money, they went into the bank and haggled with the manager for a loan and then they went off to the West Indies to try and find nutmeg or whatever. Now they issue debt on a bond market, and we wondered: what if there was a bond market for individuals?

"And the third thing we thought of was family loans. When I went to college a few years ago, I needed some money, so I went into the bank and I asked for a loan and they said 'here's the money, you can pay it back at 10 per cent over three years'. So I grimaced at this, and thought about it, and then I went to my dad and asked him for a loan," Alexander recalls. "He offered me the money at a price lower than the bank but that would earn him more than his savings account. This kind of deal has been going on for hundreds of years and we wanted to explore the possibility of using the internet to increase the numbers of dads and families."

As well as cutting out the middleman, Zopa boasts it can benefit people with irregular earnings who may have the means to pay back a loan, but slip under the radar when it comes to credit rating.

It caters for people who earn good money but not necessarily into their bank account on the last Thursday of each month, and it allays the fears of those who worry that their savings are being invested by the bank in a manner that they would find unethical.

Of course, borrowers still have to go through a credit rating system, and Zopa is not run by a commune, but the appeal to the consumer is the personal choice and the minimal costs.

"Zopa puts people who want to lend in touch with creditworthy people who want to borrow and it cuts out the middleman, so everyone gets a better deal - it's better, fairer and more transparent," he says.

"For lenders, you're getting a better return for your spare cash. The banks will typically offer you 4-4.5 per cent while we are averaging 7 per cent gross and if you're prepared to take a punt on a bigger risk, you can earn up to 10 per cent. And it's not like you're loaning all your cash to one person; it's split up between at least 50 people."

Not everyone may feel kooky newsletters belong in a financial service, and there will always be those who have a basic mistrust of lending money to someone called mooseguy37, or indeed of conducting such arrangements online.

And no matter how badly you paint the image of "greedy fat cat bankers", it is hard to replace the face-to-face interaction with a trained professional.

The banks are hardly running scared at the moment, but if Zopa continues to grow, expansion and/or copycat firms would seem inevitable. So far it is only available to UK residents, but there have been approaches from firms in over 50 different countries looking to import the service.

There has been no specific interest from Ireland yet, but the Irish Financial Services Regulatory Authority has confirmed that as Zopa is already registered in the UK, it would only need to apply for a licence to be registered to trade over here.

For the moment, the international spread begins with Zopa's launch in the US, where a similar service, Prosper, is already running. And as Alexander admits, even if Zopa doesn't work out, the precedent has been set.

"Zopa is working and it's working well. We have 77,000 members and have transacted millions of pounds, cut out the banks and people are getting better deals. It's not just financial returns but also the social rewards," Alexander says.

"Regardless of what happens to Zopa, lending and borrowing exchanges will take a large chunk of the market, because it is a better and more efficient system that works for the consumer."