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Zopa - Case Study 1

Who are they?

Zopa – the Zone of Possible Agreement – was set up by many of the team who launched Egg, and is backed by Benchmark Capital (which backed eBay), Wellington Partners, Bessemer Venture Partners (the VC firm which backed Skype), Tim Draper and The Rowland Family.

What do they do?

Zopa puts lenders and borrowers directly in touch and promises better rates for both by cutting out the middleman, though in actual fact it only decreases the role of the middleman. The site acts as a facilitator for transactions and makes sure debts are repaid.

How does it work?

Borrowers

People can borrow from £1000 to £15,000 under contracts of £10 each, in multiples of £100. Borrowers must submit to being credit-checked, and to having the results made publicly available on their profile. On the basis of this and other information collected during registration, they are assigned to one of four different markets (A*, A, B, C and ‘Young’). In the less ‘credit-worthy’ markets, borrowers will pay significantly higher interest rates, to account for the statistically greater ‘bad debt’ rate. The ‘market rate’ for each of the four classes of borrower is determined globally and not on an individual basis.

The funds are then reserved and, after more checks with credit reference agencies, Zopa approve the loan. The money is then paid directly into the borrower’s bank account, often within a few days. Any defaults or late payments will affect a borrower’s credit rating, as with a standard bank loan.

Lenders

Zopa lenders first transfer the amount they wish to lend into their Zopa holding account. This is a segregated account which is operated by Zopa and specified as containing money owned by Zopa members.

Zopa lenders can lend any amount from £10 to upwards of £25,000. Offers are made in amounts of £10 to each borrower, although the highest number of contracts any one borrower can have with a single lender as a result of his or her successful bids is 20. Lenders can choose their rates and loan lengths, and whether they want to lend in the A*, A, B, C or Young markets. Zopa provide information - including market data and expected levels of bad debt - to help lenders choose their terms.

Zopa estimate that lenders should make a 9.1% return per year if all the money repaid is lent out again (after fees and before bad debt).

Community

Members who have not lent or borrowed with each other are only identified on the site by their nicknames. If you have lent money, you will find out the real names (but not any of their contact details) of your borrowers on the quarterly statement. If you have borrowed money, you will see the real names (but not any of the contact details) of your lenders on your loan contract note. Zopa has endeavoured to create more of a community spirit by providing a discussion board, a blog and a ‘member story’.

Typical transaction

Zopa is the most classical ‘financial instrument’ of the emergent P2P finance services, and the typical transactions reflect that: relatively anonymous, diversified holdings in widely ranging amounts.

Business model

Zopa makes money by charging lenders and borrowers a fee. It charges borrowers a flat fee of £94.25 and lenders a 1% annual service fee. It also earns money through selling payment protection insurance to borrowers who want it (they have a commission based deal with Pinnacle Insurance), and through introducing people who can’t pass Zopa’s credit checking regime to other loan providers (again on commission through ‘preferred’ suppliers).

Establishing trust

Everyone looking to borrow is credit-checked and risk-assessed by Equifax, and people judged not credit-worthy will be prevented from borrowing at Zopa. The rest are put into either the A*, A, B, C or Young market. This allows borrowers to ‘get a rate that’s right for them’, and means lenders can manage their risk level. Lenders are encouraged to diversify risk by spreading money across a range of borrowers. When a person lends £500 or more, his/her money is spread across at least 50 borrowers. Zopa also establishes trust negatively, by benefiting from people’s distrust of banks.

Performance

Zopa has been successful having funded £32 million. It has seen its business increase markedly throughout the financial crisis, with banks increasingly unwilling or unable to offer loans.

Problems or limitations

Despite efforts to promote a community spirit, the primary aim remains to save lenders and borrowers money by cutting out the middleman. The forced diversification and lack of meaningful contact between lender and borrower may mean that users could feel somewhat estranged from one another.

Lenders know the ‘class’ of borrower (e.g. A*, B) but they cannot lend more than £200 to any one borrower. The bond is ultimately legal and not social — the devices for reclaiming money are drawn from the banking industry, such as risk evaluation and collection agencies. The potential social aspects of the service are not exploited to the same extent as they are in competing services (such as Prosper) since personal interaction is not of great importance to the model, although limiting the amount that a lender can lend to a single borrower does limit risk.