Zopa gears up for launch of digital bank

Zopa is reputed to be the world’s first peerto-peer (P2P) lending platform. It claims to have created the business model for P2P lending. That was in 2005, and it has been so successful since that it is now the single largest non-bank consumer lender in the UK, with more than GBP1.5 billion ($1.97 billion) in outstanding personal loans.

Meanwhile, P2P or marketplace lenders worldwide appear to be struggling in recent years, particularly those in China and the US.

Stocks of listed P2P lenders such as Lending Club, On Deck and Yirendai, have performed poorly, amid concerns about their prospects in a rising interest rate environment and their exposure to riskier credit segments, which are either below or just above subprime. The mis-selling by US-based Lending Club of wrongly risk-classified assets to an institutional investor uncovered in May 2016 did much to harm investor trust and confidence in such online lending platforms.

In China, P2P platforms have come under increased regulation. The lack of supervision in the past had allowed the sector to grow rapidly which resulted in a number of fraud and scam, including Ezubao, reportedly China’s biggest P2P platform but which later turned out to be a Ponzi scheme that cheated close to a million investors of about $8.2 billion over two years. Chinese authorities had from August 2016 introduced tougher rules on the industry.

Zopa on the other hand seems to have managed to buck the trend. CEO, Jaidev Janardana, attributes the success to its ability and effectiveness in managing credit risk and keeping the cost of funding low.

Keeping funding cost low

Janardana believes that Zopa’s robust credit management process enables it lower its funding cost and to price its loans competitively in order to win market share from not just traditional lenders but other P2P players.

“I’m very proud that as a P2P lender I give the lowest return to my investors. And I’m able to still create demand at my lowest return because my risk performance has been so good that people understand this is a low risk asset and thus they will not get too much return,” he said.

And it allows Zopa to pass on that low cost of funds in terms of competitive pricing for borrowers. And thus, be able to fight head-to-head with deposit funded institutions.

“That comes with the credit risk management and is a huge part of our proposition to our investors. My pricing is good because we run at very low cost, our technology always works. When the people who call us get a great experience that’s because my technology always works.”

Zopa’s loans are funded by either individuals or institutions who bear the credit risk and it manages the book for them.

About half of the money is lent by individuals, about 70,000 who have lent an average of GBP10,000 ($13,140) each on the platform. Slightly less than half the money comes from institutions, including banks and fund managers.

“We have a fee-based model. When we originate a loan we try to take a bit of a fee and we also take a cut from the spread on an ongoing basis. Which means that we’re not unlike a lot of the U.S. platforms. About 30% to 40% of our net contribution comes from servicing fees, which makes it a bit more sustainable model,” he explained

He added: “The product itself, we have made very simple and easy to understand. We have removed almost every single fee in terms of delinquency fees, statement fees, and tons of fees that customers hate and we have just taken it out. When you get a loan, on day one you will see here’s your request for credit and that includes everything. The only time we will charge you a fee is if we have to take you to court. And you have many options not to go to court, you just have to talk to us. That is simplification of the product and the experience.”

Leveraging data and technology

But to do that effectively requires great technology and credit risk management said Janardana.

He explained that borrowers are graded between A*, which is the lowest risk category with low expected credit loss of about 20 basis points, and the highest risk category E where losses are in the 8% to 9% range. Investors or lenders, whether individuals or institutions, can choose to be exposed to only the A* to C, or A* to E risk categories.

“So, we do the credit risk management for everybody. The choice is somewhat limited.

And you can choose between those two. When you invest GBP1,000 ($1,314), we break that down into smaller GBP10.00 ($13.14) loans that go to different borrowers. There is diversification but from a legal standpoint you actually end up having one-to-one contracts, you have a legally enforceable contract with each borrower for £10.00,” he elaborated.

It helps that UK has a very strong credit information infrastructure. “We are very lucky that we live in a very data rich environment. So, when somebody applies, we can from the credit bureaus look at their last seven years of history in any credit item they might have. And credit item includes current account if they owe a limit on that, telephone bills and utility bills and all of that.”

Janardana added: “We end up getting about 3,000 variables on the person plus they work out all their financial associations, financial associations mean you can have a joint account with anyone, you get all those variables. And what that means is that we are able to capture a lot of the non-linearity in the credit models. 

So, from a customer’s standpoint, the strongest value proposition is the ability to instantly download the credit decision and offer a good pricing.

Getting into banking

Zopa is also in the midst of launching a digital bank which will be focused on unsecured consumer lending. So, in addition to personal loans and auto-finance, it will also be introducing credit cards. And it will also take term deposits, all online, very similar to what it is doing today, serving the same consumer base, leveraging the same technology and credit risk management that it has been doing in the past.

However, it does not intend to have current accounts. Instead, it will leverage open banking and create a PFM, Personal Financial Management app, which people can integrate their current accounts on.

Janardana sees a clear distinction between unsecured lending in the credit card market and P2P platform and how consumers might choose them.

“I think most consumers think about loans when there are big purchases, like a car, a home improvement. But if it’s a day-to-day spend then they use the credit card. And at some point, then they might say, I want to consolidate the credit card and put it on to a loan. That’s the mindset,” he observed.

“So, from a customer’s standpoint the strongest value proposition is the ability to instantly download the credit decision and offer a good pricing”

It will continue to have a banking business and a peer-to-peer business. So, there will be two different entities and they will continue to exist side by side. P2P is an asset class and business that it created and is committed to and there is strong consumer demand.

In his view, P2P is a very effective mechanism and very efficient for off balance sheet securitisation. Finding the right mix between the two will be the goal as it gives different leverage points to grow very fast with P2P without having to have the capital. And it is capital light, when capital is constrained it is the way to grow. However, when there is enough capital then the bank offers another option. So, having that flexibility is a huge strategic advantage.

But ultimately, Janardana believes that the P2P business is a huge differentiator because it has created an emotional connection with consumers who have invested, lent or borrowed money through the platform.

“Which I think creates a stronger bond and trust and we want to continue to leverage that in the future,” he concluded.