The Rocky Road for Innovative Lending
by Ritchie Mehta (14 November 2008)
Innovative lending organisations such as Zopa, have turned the conventional banking model on its head and challenge the very concept of financial intermediation. In essence, banks take in deposits from savers (in return for interest) and then lend the money to borrowers at a higher rate of interest. The difference between the two rates is the margin, which the bank takes as its profit. One of the many advantages with this model is that it acts as a middleman between the two parties who would otherwise not know each other. Additionally, the risk of default is far higher if an individual lends all their money to another, going back to the age old proverb of “do not put all your eggs in one basket”. A bank is able to spread this risk thus minimising the impact of a default.
However, with the advent of the internet organisations such as Zopa are able to bring people together and disintermediate the banks from the process and thus potentially offer higher rates for savers and lower rates for borrowers. The concept is further enhanced, as only a small amount of an individual’s savings will only be given to one borrower thus replicating the banks risk based model.
So in the current climate, how are they doing? On the whole, organisations such as Zopa were off to a slow start in the UK, but are on course to turn a profit this year. The current lending environment in the UK may help such businesses as more people look for alternative ways to get credit, as banks close their doors. However, Zopa’s performance in the US proves that no one is immune to the credit crunch. It has been reported that they are due to close down their US operations in light of the current market conditions. It looks likely that they will continue to concentrate their efforts predominantly in the UK but also in Europe.