The FT picks up our social lending debate

The Financial Times' Money Matters Blog has picked up on the debate  between James Gardner and I about Zopa.  They've asked readers for comments.  I thought I would re-post the responses here as it adds to the richness of the context of our discussion.

Martin Campbell (the one that started this off) responds:

Certainly wasn’t expecting it to all kick off as it has, but of course there is only one thing worse than being talked about...

Can I just take the opportunity to correct a fundamental
misunderstanding that has plagued much of the debate across these
various blogs. Zopa is not a lender like a bank is. It is a
MARKETPLACE. It is a radically different proposition from the banks.

Zopa does NOT set the rates. Lenders make offers at the rates that they
choose themselves. If borrowers think the rate is a good deal, they
will take it up. If they don’t, they won’t and lenders will feel
pressure to lower the rates they are offering to a level that borrowers
will accept.

So all this toot about ‘price wars’ and killing-off Zopa when it
becomes big enough is borne of a lack of understanding of how the Zopa
model works.

If the banks wanted to kill-off Zopa with a price war as James G says
they will, they would kill themselves off first; the extent to which
they would have to reduce their current rates is too big, the overheads
they have to cover are gargantuan compared to Zopa’s wafer thin
operational costs (and charges) and because they would have to offer
these new hugely loss-making rates to the whole country.

They would be dead long before Zopa would be.

Also, in response to an earlier comment, Zopa carries out all the credit and affordability checks that the banks do – and more.

Far from being denied the information banks have, Zopa obtains far more
than most do, and takes more factors into account, even a would-be
borrower’s eBay rating. Zopa also aims at a higher standard of
“responsible lending” than most banks do – partly because it is not its
own money that is being lent. The proof that they have got this right
is a default rate that has never been higher than 0.5% - radically
lower than the banks achieve.

GG says:

Zopa provides great rates for lenders and borrowers but, for me, it's
the satisfaction of beating the bankers at their own game that makes it
great.

Of course, there is no Government guarantee and that is why I focus on
the lowest risk markets. At the moment, returns are double those of the
best cash ISAs.

Vinay Basavaraj states:

I am sceptical of the role Skopa, and similar potential replacements,
will play in the future. One fact that clearly undermines Skopa is the
information advantage that banks possess. By means of the payment
system, banks have acquired invaluable information of potential
borrowers. What remains to be seen is whether this information
advantage is eroded by an 'efficient market'.

Othermotte says:

I am a Zopa user and very pleased with it. I had money that I wanted to
earn interest on and the only place to offer a decent return was Zopa.

The fact that it was "social lending" was an added incentive. In the
past, I have had money in a number of mutuals and always voted against
demutilisation, despite the bride of shares that was offered. I think
that the demise of building socities was a bad thing and Zopa offers
something closer to that model. I actually enjoy browsing the comemnts
from the myriad of borrowers and the connection that it makes to real
people.

But the bottom line is that it is a good interest rate for savers.

Andy from Bristol adds:

Whilst Zopa was very competitive for loans of £5K+ over terms of 4
years or more - it seemed to be in the top 2 or 3 providers offering
just under 8%pa (3 months ago) - it really came into it's own for
smaller loans over shorter terms. As someone who is reasonably careful
with money, I wanted to borrow no more than I needed & repay it as
quickly as I could afford - none of the big players (ie banks/building
socs) are interested in small fry contracts so they either don't offer
them at all or offer high rates, circa 15%. One thing worth noting re:
Zopa is that the rate offered seems to be VERY sensitive to your credit
score - I was offered a slightly higher rate (say 30 bips higher) than
that published on moneysupermarket & have a good credit rating, but
my wife, who I would imagine scores slightly better than me, was
offered a rate 10 bips lower than me. The service was good & I
would definitely use them again presuming their rates stay competitive.

Calc says:

I can only say that the returns offered by Zopa to it's lenders is
considerably higher than that offered by any bank, the rates offered to
it's borrowers generally, though not always, lower than those offered
by the banks. It seems to me that both lender and borrower are well
served.

There are though riskes to the lenders, borrowers may default, but Zopa
appears to do as much as the banks to credit check those who wisht to
borrow; I understand that 2/3rds that apply for loans are turned down.

My personal experience is of a lending body that was willing to offer
me a £ 5,000 loan over three years at 8.1 % as against my high street
bank that intitially proposed one at 16 % before reducing it on protest
to 14 %. As an excersice I credit checked myself and found my credit
score to be '999'; whereas I accept that different credit agencies may
produce different credit scores based on different criterea, I assume
that with all my credit rating is fairly high, I therefore wounder what
the bank would charge me had not been so good.

The fact that Zopa exists indicates perhaps a failing on the part of
our banks. I doubt Zopa and it's ilk will replace the banks but they
are a highly valuable adjunct.

Comptroller adds:

Zopa is, after four plus years, very small, has operating deficiencies
and obviously not fulfilling its initial business objectives (operating
losses of £1million on a turnover of £673,000, reduction of staff
literally in half from 2007 to 2008.) Activity spiked in early 2009 and
has continued with steady growth but has nothing like the momentum
required to threaten the banks.

Despite recent publicity on national radio and in the press it's
activity is still less than the average branch of a High Street Bank
(and about the same number of staff.) The rates of return are not bad
but thre is the risk of bad debt, many lenders think this risk was
inadequately flagged when they joined. Anomolies with tax and the
better returns available elsewhere for about the same risk limit growth
fo the moment.

In time Zopa will probably gain some critical mass if it's backers are
prepared to be patient and continue to support it, but it is unlikely
that it will challenge the Banks anytime soon from it's current
position of less than 0.1% of the unsecured lending market in the UK.

GRR counters:

I've lent out money through Zopa since its early days; it's a fantastic
innovation, aiming to create the perfect market, and so letting prices
find their own equilibrium by the laws of supply and demand.

Granted, there's room for profiteers to make a killing by offering that
few extra quid to make up someone's overall loan at a premium rate, but
that's how markets work, and as the number of participants increases,
that will continue to drive rates to a fair level for all.

As a lender in the current market conditions, Zopa offers a far
superior return to even the best depsit accounts / fixed rate bonds -
even after taking account of the notional cost of bad debts. However,
you can't predict what will happen with your particular borrowers, and
you have to accept the fact that -statistically speaking - it's
possible that all your borrowers could default! But to say that the
risk isn't evident to lenders is totally unfair - all the rates quoted
make allowance for bad debts, there is ample guidance (and FAQs, etc),
and the very nature of the model (multiple small-denomination loans to
multiple individuals in predetermined credit bands) allows lenders to
minimise their risk of exposure to unacceptable levels of risk of
default.

Add to this the feeling of doing something socially responsible, and a
really well-thought-out and user-friendly interface, and Zopa is a
winning proposition - just awaiting the critical mass which it needs to
really take off and challenge the incompetent and immoral institutional
lenders.

Colin Henderson throws in:

The rates will be set by the market based on supply and demand. This is
not the core of the argument however. The debate turns on business
model characteristics.

Banks are entering a productivity crisis. Their opportunities for
revenue growth during a period of consumer retrenchment and
deleveraging is low. That is why banks are looking at exiting large
nmbers of branches. However they have not laid the groundwork by
automation of the customer processes needed to support less branches.
Automation has been focussed on data management and not customer
interaction.

Zopa is built as an efficient platform and has begun to automate
customer processes such as identity verification, and integration of
credit scoring with lending processes in ways banks have not.

The coming crisis of productivity will define losers and winners in this debate.

I_BURDON reports:

I lend on the Zopa Market it help people to get out of the credit
crunch. Yes it does work and you can earn more than the banks will hand
out in intrest. Free trade should worry the banks. But the banks are in
a protected position , given by the UK goverment on the following
grounds.

1) Deposits protected.
2) Bad debts written of by the bank . HMRC does not allow Zopa Lenders to have bad debts written off against profits.
3) The Banks have a Goverment share holder.

So not a level playing field by any means. I would think the OFT would be trying to level things up. But who is the Piper.?

So now you have it the UK Goverment is against free trade in financal
services and has a vested intrest in protecting the the banks. When did
nationalization become UK goverment policy?

Pete tells us:

I have been a borrower from inception of ZOPA and paid off within a
year. I am now a lender and have over 1200 borrowers with a default
(lost £80) rate of 4 and a late payment of 4 of whom 1 is paying at a
reduced rate. I like this , as it gives the chance for a borrower to
still pay back what he/she can afford and if I were in that situation
then I would feel that I would make every effort to pay back my debt as
the system allows compromise.

Overall. I am returning around 7% on my lending; which I am comfortable
with in the present climate and (this may seem too sugary); I get to
read the comments of people I have lent to, and their success stories
and ambitions. Yes, it's a tough world at the present, but I reckon
that I am doing my little bit to ease it for the people who need a
loan, and through Zopa, I am reasonably assured that the people I lend
to are not going to take advantage.
I think this is so much better than the corrupt and overpaid banking
system, particularly as interest is only paid on outstanding balance
and there are no early repayment penalties - That is refreshing!!

Hope this helps the blog - Hope this helps 'Stu**' the banks whom I do
not trust , particularly as most of them are now owned by our beloved
government - and will we as 'shareholders' get any dividend payout from
our new aquisitions?.... watch this space, but I think pink elephants
may be seen in the sky before this happens.

Whilst Devongirl elaborates:

As a new lender in Zopa, I'm very pleased so far, but only time will
tell just how many bad debts I experience. If they are as predicted by
Zopa, then I shall be making an excellent return comapred with cash in
a bank. However, this is not really comparing like with like, as I
cannot withdraw my money on demand. Every loan I make will be repaid
gradually over three or five years. So I regard my funds in Zopa as an
alternative form of investment, not a cash deposit. But for this
reason, much as I like Zopa, it can never substitute for a bank -- not
that it tries to, except perhaps from a borrower's point of view as
provider of personal loans.

Toontopo pipes in with:

I am absolutely convinced that Zopa and similar platforms will become
an ever more important competition to banks. Personally I don't think
of Zopa as the banking equivalent to e-bay, because unlike with e-bay,
there is no one-to-one relationship between lender (seller) and
borrower (purchaser). Rather I like to think of Zopa as a facility that
simply takes the potential of internet banking to the next level. Even
if occasionally banks may still make better offers to potential
investors or borrowers, in the long run they simply cannot undercut the
substantial advantage that Zopa has in terms of overheads, an advantage
that is entirely down to the potential inherent in internet. For those
who understand German, I recommend this interview with Konrad Hummler,
president of the Swiss private bankers' association: http://www.nzz.ch/finanzen/impulse_archiv_juni09/impulse_juni_2009_1.2656628?video=1.2673974
He makes, with remarkable candour, the same point (he doesn't mention
Zopa specifically though), and I think he knows what he is talking
about.

Lemondy is not so agreeable:

I have tried Zopa as a lender and will not be doing so again. I think
that many retail punters who want more risk/return than cash would be
better in fixed interest (i.e. corp bond funds) if not equities.

I fear that many retail punters do not understand the risk of Zopa
lending, do not appreciate the FSCS guarantee they get from staying in
cash, and don't understand that the quoted returns are BEFORE TAX.

Even in these exceptional times, for much of the last 12 months, I
could have got better returns in a cash ISA than in my Zopa loan
(expected return ~= 6% after fees, bad debt), plus liquidity, plus no
risk to capital, plus FSCS safety net.

If Zopa improved the liquidity of loans (i.e. shorter minimum period,
ability to sell on loans), then, possibly, I could see it might be a
good idea people, maybe non-taxpayers at least.

Whilst Freckles doesn't agree with that:

Remember the Breweries?
You cant have real ale - your have what we give you!!!!!

And so dream on Breweries (they lost) and dream on the banks, yes zopa
can make a difference and continue to grow if people like me (retired,
with nest-egg ) continue to get bad deals from banks and building
societies on our capital with pultry, insulting interest rates.

I have lent money through zopa for 5 months early days, being a bit
cautious, but its working, takes a bit of time to get the money
invested and rolling back, but its happening

I am impressed, but having trouble interestings my peers in similar
position to me to invest - something `new` worried about the defaulters
(heaven knows however the money we have lost on the stock market and
they accept this crazy comparison)

The current problem lack of strong advertising - never seen it on a
billboard, bus stop, tele etc. that needs to be addressed marketing!!!!!

Next I would like to see a `L` catogory of lender - standing for
established lender, so that lenders can get preferential rates from
there peers - next year I would like to pay off my car loan, wouldnt it
be nice if my zopa mates offered me 0 - 4% I know they would be loosing
interest but if we all put a bit aside to finance our own loans through
zopa - a double wammy!

Keep going zopa - just dont brew beer!

SoupS asks us to read monevator's view, who has seen bad debts at Zopa rise to 2.68% recently, whilst Richard027 adds:

As Bill Gates reportedly said, "the world needs banking but it doesn't
need banks". The way out of the financial crisis is not the prop up
existing banks at all costs but to ensure banking services are
available. This is where Zopa comes in and recreates the social benefit
of banking, namely the availability of credit and the rewards attached
to saving both of which encourage long-term planning in individuals,
without sucking up all profit for the middlemen. It is a new form of
mutualism. This is such an attractive propositon for both borrowers and
investors that it seems inevitable that it will grow much more
important than it is now. Plus, it has a number of independent
comparative advantages - entirely internet-based, absence of legacy bad
debt, not at the mercy of wholesale markets - that can only further
strengthen the model.