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The internet's answer to the credit crisis, The National 12.09.2009

Anyone who has tried to borrow money this year knows how difficult it can be to obtain credit. The global financial crisis has caused more than a few established banks to go out of business, nationalised many others and left the rest dealing with shrunken balance sheets. Though the worst seems to be behind us, the experience has drastically changed the borrowing and lending landscape. The ensuing lack of credit from conventional sources is shining new light on a form of financing based on the internet: social, or “peer-to-peer” (P2P), lending. At websites such as Prosper.com and lendingclub.com in the US and Zopa.com in the UK, borrowers and lenders come together in a very similar way to buyers and sellers on eBay – not surprising, given that many of the same people who backed eBay in its formative years are now involved in P2P lending.

Business is booming in spite of the recession: Zopa has handled nearly £50 million (Dh301m) since it was launched four years ago, and expects to handle more than £35m this year alone. About 300,000 people are registered on the Zopa site, with 20,000 of those are currently active lenders or borrowers. In the US, Prosper.com recently acquired its Securities and Exchange Commission (SEC) registration, paving the way for significant growth in lending.

While the sector is so far virtually unheard of in the UAE, its business model, which links borrower and lender in a much more personalised way than large banks can afford – or want – to do, makes it ideal for a region that places great value on knowing one’s business partner. For the moment, however, most analysts think there are basic reasons why our region is not ready for P2P. Zeeshan Saleem, Barclays’ director of consumer banking in the GCC, said it would not work in the UAE at this time because a market for it does not exist.

“The UAE is a small market – it has a population of 4.5 million and around 50 banks,” he said, adding that the country does not have the necessary regulatory and legal framework in place. “What happens if the borrower leaves the country? There is no recourse. Banks can offer better pricing for borrowers because they have the risk management and collection mechanism in place.” In many parts of the rest of the world, P2P’s popularity stems from its core nature: you do not have to have millions of dollars kicking around to become a lender and make a profit. It should not, however, be confused with microfinance. The majority of lenders on P2P sites are not being altruistic; they are there because the rates are so competitive. The fact that they can make a profit by helping out another individual is, however, a nice bonus.

A research project on internet-based social lending conducted in 2006 by the Social Futures Observatory, a UK-based think tank, found that most of the users of these sites were “minipreneurs”: small-scale, sophisticated investors, most of whom did their banking online and who were attracted by the transparency and perceived ethicality of social lending. “In this company we promote the fact that we are transparent, fair and ethical in how we do business,” says Giles Andrews, the managing director of Zopa. “We are the opposite to the greedy bank that tries to make money out of people who fail.”

The competitive interest rates come from cutting out the middleman, the mainstream bank. With significantly lower overheads and no hidden penalties, Zopa makes its money by charging a fixed fee to borrowers and a percentage fee to lenders. In the listings section of Zopa’s site, would-be borrowers post photographs of themselves and a description of why they want the loan. Reasons range from pure anti-corporatism (“Help me stop lining the pockets of HSBC and Halifax”) to wedding expenses (“Help me give my fiancée the day she deserves”) to simply “I’m looking to buy a used car”.

Zopa boasts a low default rate of 0.39 per cent since its launch in May 2005. This is due in part to the careful screening process and the credit rating it gives those it takes on as borrowers, but also in part because the site avoids the psychological effect some borrowers display when dealing with a faceless corporate entity. “There is something to people knowing they are borrowing from individuals,” Mr Andrews says. “It makes people feel more beholden and therefore less likely to default.”

Zopa’s name comes from a business theory, the so-called Zone of Possible Agreement, which indicates the overlap between the lender’s bottom line and the borrower’s top line where an agreement might be found. Mr Andrews says Zopa’s main role is to facilitate deals: “We add value to lenders so they can make informed pricing decisions”. To obtain a loan on Zopa, a borrower will first have their credit rating assessed by the company. Zopa uses a combination of data from Equifax, a leading credit rating agency, and the loan application to determine risk. Would-be borrowers are warned at this stage that consumers with low credit ratings may not find the financing he or she wants. In addition, applicants with repeated credit defaults may be rejected by the company outright.

Candidates are put into one of five different markets according to their credit rating: A*, A, B, C or a new market of young borrowers aged between 20 and 25 called “young”. The loan requirement is then submitted to the Zopa marketplace of individual lenders’ offers and the composite rate of interest on the loan is calculated in real time and quoted to the applicant. The borrower decides whether to proceed and, if he takes up the loan, will agree to make one monthly payment to Zopa to cover the separate agreements with each of his lenders; the money will then be transferred via Zopa’s client accounts into the borrower’s bank account.

The “young” market is a new venture for Zopa and reflects the company’s desire to encompass a broader market than that of banks, but with a sensible grasp of the associated risk. In this market, Zopa takes on those who have not yet had the time to fatten up their credit files but who may still be good risks. Similarly, the company is tapping into the so-called “olderpreneurs” demographic by linking up with PRIME, an initiative of Prince Charles’s charity, the Prince’s Trust, which is designed to help older people with business ventures. Under this scheme, Zopa lenders can provide start-up finance for currently unemployed entrepreneurs over 50. A degree of risk has been taken out of this process by PRIME vetting the business plans first, and then guaranteeing 50 per cent of the loan.

Would-be lenders can log on to Zopa.com and state how much they want to lend. If they lend £500 (currently Dh3,041) or more, this amount can be divided into at least 50 units to spread the risk and allow lenders to diversify their portfolio. They can, however, choose to split up their investment differently. Lenders then select the risk profile they want – the credit rating group and loan repayment period they wish to lend into – and Zopa will steer them towards the borrowers who fit that profile and agree to pay the lender’s requested rate. Alternatively, would-be lenders can log onto the Zopa listings section and hand-pick the individuals to whom they wish to lend. This version is the predominant set-up on the American site Prosper.com, but Mr Andrews estimates only 5 per cent of Zopa’s deals come through the listings section.

There is a degree of risk with P2P lending, given that all the loans made via the site are unsecured. Zopa attempts to minimise default risk by breaking down every loan into small units and externally credit-checking the recipients. For those worried about what would happen if Zopa itself were to go under, Mr Andrews says the company holds investors’ money in trust accounts and has made arrangements with a debt collection agency to follow up on bad debts for the duration of the loans.

For legal reasons, Zopa can only be used by residents of the countries in which it has sites. For now that means the UK, Italy and Japan, countries that Mr Andrews describes as having “friendly regulatory regimes”. Requests to set up sites in the UAE and Eastern Europe have been received, but for now there are no plans to expand eastward. A local entrepreneur, Fadi Feghali, the vice-chairman of One to One Hotels and a longtime Abu Dhabi resident, agrees with Barclays’ Mr Saleem that the UAE market is in the wrong position to embrace P2P. “Financially capable investors are not interested in investing through a website, especially now. They just have no trust in the market,” he said.

Mr Feghali added that those with lower incomes would be more likely to invest in their home countries, buying land or a house, than to invest over the internet. A potential P2P lender in the UAE would also need a Sharia-compliant option, said Nawal al Hosamy, 39, a UAE national living in Abu Dhabi who works for Masdar. “In Islam you can’t charge interest when you lend money to individuals. Most Muslims prefer to go to an Islamic bank.”

Elsewhere, however, P2P lending is going from strength to strength. While P2P’s market share has not come close to putting fear into mainstream banks so far, Zopa and its American cousins are hard at work consolidating their base. Zopa is lobbying the UK government to have investments in it eligible for Individual Savings Accounts, or ISAs (a tax-free way of saving in the UK), which could make P2P-based funds a part of many more portfolios. The company is also looking into offering mortgages and managing insurance-side risk for its investors.

The novelty of lending money online may turn more traditional investors away, at least for now, however. “I love internet banking because I like to see it in front of me, but I don’t think we would do this [P2P lending],” said Emma Tod, 34, an office manager from Australia who has lived in Abu Dhabi for two years. “This sounds like more a short-term investment which you would need to monitor more closely. We prefer to find an investment that we can put money into and it kind of takes care of itself.” Additional reporting from H Michael Jalili

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