zopa case study

Introduction Zopa (Zone of possible agreement) is a UK based peer to peer lending platform that brings British residents who want to lend the money with people who want to borrow it. Lenders are giving money not to one person but many people that have similar credit ratings. Started in March 2005, Zopa now has over 500,000 members and has funded over £ 479 million loans. Because Zopa is not a bank and it doesn’t lend money by itself, the capital requirements to run the business are relatively small. The birth of Zopa Zopa was co-founded by Richard Duvall, James Alexander and David Nicholson, which were all involved with Egg Bank. The company was funded by Benchmark Capital (eBay investor), Bessemer Venture Capital (Skype investor), Wellington partners and private investors. In total, there was £ 26 million raised for Zopa initial investment. Zopa sees business opportunity based on two facts. First, it bridges a gap between people who want to get more interest in their savings and people who want to have lower interest in their credit. Furthermore, based on market researched conducted by the company showed that there was a potential market of “free formers” that haven’t been tapped by traditional financial industry. “Free formers” means people who are self-employed, project-based or freelances such as consultants or entrepreneurs. According to the research, there are as many as 6 million “free formers” of 60 million UK population and this segment was growing very fast. It also was happening in developed world including US. With a considerable growth in internet reached and internet banking usage in UK, Zopa believed there are increasing consumer’s confidence in using online financial services. Zopa vision is to become a platform where free formers can have financial option beyond the traditional banks and provide virtual community that is aligned with free formers culture and lifestyle. Zopa Operating Model People registered online as borrowers or lenders. Once they had registered, lenders can loan money to a group of people with similar creditworthiness. Zopa assessed borrowers credit scores using the same Equifax credit rating that was used by UK retail banks and only offered services to borrowers who have an A*-, A-, B rating. The company cooperated with identity checking agency to verify all lenders and borrowers’ identity. Zopa had its own underwriter team that assessed borrower’s ability to pay and only if they can passed the assessment; borrowers can enter market-matching system. As many as 75% of people who apply to Zopa has been turned away by underwriting team. Lenders offer loans to the market that was segmented by borrower’s credit rating and loan term. When lenders placed their money, it will be separated into £ 10 each or at least 50 borrowers. The lenders offers were ranked by the interest rate that they set (lowest to highest) and by the time they placed the offer (earliest to the latest). When borrower made a request in the market, the money was taken from each lenders based on those rank order until the full amount. The interest rate was charged by the average rate of every lenders. If a borrower repaid quicker than original contract, the lender paid no additional fee but if a borrower defaulted, a collection agency will undertake the outstanding

amount free of charge for 120 days. If the agency can collect the debt after 120 days, the lender agreed to sell the debt to agency for a determined price at that time. Furthermore, the borrowers would be suspended on Zopa membership and Zopa would passed their details to credit rating agency. Zopa members who have failed to repay their debt received a mark at their credit history.

Zopa charged borrowers 0.5% fee of their loan and lenders a 1% annual service fee. If borrowers took £1,000 loan, they will be charged a £5 fee. The fee will be added to loan hence bringing the money borrowed to £1,005 then the fee will be deducted up front. The borrower would have £ 1,000 loan transferred to their account. Lenders lending £1,000 at 6% will earn £60 every year if the borrowers were not default. Lenders would pay fee 1% of outstanding amount or £10. Zopa deducted the fee on a monthly basis once lenders had received their payment. Nowadays, Zopa has introduced safeguard fund to protect lenders from defaulted borrowers. It will gives lenders their money plus interest once borrowers default. This fund is charged to borrowers when their loan is approved. The Zopa safeguard is held in trust by third party. With around 50 employees, Zopa can maintain it low cost operation and take up challenge against traditional banks. Zopa Performance Financial crisis played important role to Zopa performance by driving up the cost of bank lending. Meanwhile, interest rate remain low which have made difficult for savers to get real return. Zopa has grown very fast in last 3 years. In 2010 Zopa total loan was £100 million then it increased its loan to £175 million in 2011 and now it has £400 million loan (See Exhibit C). It reported pre-tax profit of £26,000 for the first time. The company now expand its loan into businesses such as plumbers and window cleaners. Borrower’s main benefit from Zopa is that they can borrow small amount of money relatively cheaper for short period of time than traditional banks. The average rate of Zopa loan is declining since it launched (See Exhibit D), in 2013 the average rate is only 5.8%. It’s cheaper than credit card and loan rate from most Banks. This one possible reason why Zopa has low bad debt rate. Although it’s increasing, only 0.7% Zopa loan turned into uncollectible debt in 2012. The company use conservative approach by expecting the bad debt around 2% (See Exhibit F). Zopa CEO believed that the low default rates partly because the company puts social aspect into lending. Zopa members can see the username of other members whenever they lent or borrowed. Members also can see general details such as age, marital status, location and loan purpose. Lenders can track their repayments and borrowers can communicate with lenders with messages typically explaining more what the loan for of simply to say thank you. If the bad debt can be maintain, Lenders can have a higher return than traditional savings accounts. Unfortunately, Zopa returns has been falling since it was founded. Lenders used to get 9.1% from A* borrowers in 2010 (See Exhibit E) now they could only get 6.7% in 2013 but as Zopa is not a Bank or building society, Lenders income in Zopa is a tax free, however it’s up to Lenders to declare to the taxman.