www.zopa.com
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James Alexander
- Zopa's CFO
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ZOPA - Make Money by Becoming a Bank!
Interest-rate cuts are great news for homeowners, because they lead to falling mortgage repayments. However, they do savers no favours at all, because falls in the Bank of England's base rate are inevitably followed by cuts in savings rates across the board.
At present, the Bank of England's base rate is 4.5%, which is very low by historical standards. For example, in the 1980s and early 1990s, the base rate was often in double figures, making it easy for savers to earn, say, 10% a year before tax. Nowadays, although savers have a choice of more than four thousand different savings accounts, very few of these pay more than the base rate.
Indeed, with the annual rate of inflation at 2.3% in October, a basic-rate taxpayer (paying 20% savings tax) would have to earn a pre-tax 2.88% a year merely to break even in real terms. For a higher-rate (40%) taxpayer, the bar is set even higher: the break-even point is 3.83% a year. With the vast majority of savings accounts paying less than this rate, many well-off savers are actually seeing their money fall in value over time.
British banks are among the most profitable in the world - the UK's five largest banks are predicted to make a combined pre-tax profit of around £35 billion during 2005, which puts them among the biggest-earning businesses in the UK.
However, critics of these big banks argue that their profits are excessive, and that British borrowers and savers are getting a raw deal while bank shareholders enjoy juicy returns. Banks have also been accused of reckless and excessive lending, which has contributed to record levels of personal debt throughout the UK. Furthermore, banks tend to reserve their best deals for new customers, while leaving loyal borrowers and savers in the lurch.
Still, although it may appear that banks have a stranglehold over lending and borrowing, one company has big plans to break up this cosy cartel. Online financial exchange, Zopa, launched in March 2005 introduces savers to borrowers, removing third parties such as banks from the equation. In effect, Zopa is attacking the generous margins that banks enjoy, which come from lending money at much higher rates than they pass on to savers. By enabling peer-to-peer (P2P) lending, Zopa cuts out the middlemen (the banks), which means that lending members earn higher returns, while borrowers are attracted by low (often market beating) loan rates. Zopa acts as a clearing house for loans - an "eBay for lending", if you like.
Zopa's management includes Richard Duvall (one of the founders of Egg, the world's largest online bank) and James Alexander (former Strategy Director at Egg, during its move into profitability in the UK); one of its backers is Benchmark Capital, one of the original investors in eBay. Zopa makes its money by charging borrowers an exchange fee of 1% of their loan and receives commission from the sale of payment protection policies.
Here's how it works: let's say that you have £15,000 on deposit earning a fairly ordinary 3% a year. To boost your returns, you transfer £3,000 to Zopa and lend this money to borrowing members. Currently, Zopa lenders are earning an average annual return (before tax) of 7.3%, before taking bad debts into account. This interest is paid to you monthly, which is an improvement on those savings accounts which pay only annual interest.
Zopa lenders set their own lending rates, and can choose to lend to top-ranked "A"-rated borrowers with high credit scores, or "B"-rated borrowers, which have slightly lower credit scores. As always, higher returns mean higher risk, but Zopa manages this by spreading your capital across at least fifty borrowers. Also, it only recruits borrowing members with an annual income of £25,000 and subjects each to thorough credit checks. It is important to stress, that the security and risk management mechanism, employed by Zopa is the same as that of the large banks. Together, these actions help to produce more predictable returns and enable interest to be paid monthly.
The expected annual return after bad debts is 6%, which beats all mainstream savings accounts. Nevertheless, your actual return could be higher than this because, according to Zopa founder Richard Duvall, "In our first eight months in business, not one single Zopa borrower has missed a repayment, which gives great confidence to lending members".
Lending through Zopa also presents an alternative "asset class" for investors to consider, which offers superior returns to savings accounts, but without the unpredictability of investing in shares. It could be described as the "bond market for individuals". So, if you're earning ordinary rates of interest on your spare capital, you could diversify your portfolio and boost your returns by becoming a Zopa lender. The minimum investment to become a Zopa lender is £500; the maximum is £25,000.
Finally, for a limited period, Zopa is offering a 2% bonus to lending members who offer the best rates to borrowers. This incentive is another reason for fed-up savers to entrust part of their savings to Zopa to gain even higher returns. So, what's stopping you from giving your savings the Zopa treatment?
By November 2005, just eight months after the launch of Zopa, over 40,000 people had signed up as lending or borrowing members. Person-to-person lending is clearly here to stay.