You give your money to Zopa. Zopa divides it up into chunks and combines it with money from other 'lenders' and gives it to borrowers (which it has performed credit checks on). The borrower pays a fee, a part of which is given back to the lender. Also, if someone defaults Zopa goes after them.
You have a contract directly with the borrowers, not with the institution. If the borrowers don't pay up, you loose that money. Zopa doesn't pretend that you have money sitting in a vault somewhere that you can take out whenever you like.
To be fair to banks they don't really try to push that vault myth either, but that is the mental model people still use when interacting with banks.
The most significant feature of modern banks is fractional-reserve lending. Your bank borrows $100 from you (e.g. by letting you deposit money in it), lends $90 to your neighbor, and predicts that by the time you want your $100 back, someone else will have paid off its loan so that the bank has $100 in liquid cash sitting around. (If that prediction turns out to be false, then your bank borrows money from another bank, and if no other bank is willing to lend to it, then the government steps in.)
There's no way you can play this game without a large amount of money and a willingness to jump through the government's regulatory hoops.
It doesn't make money. Banks do that (well, prior to the recent financial crisis).
See Prosper, incidentally, which had lending peers decide which loans got funded and at what rates. If you think BoA was bad at estimating default risk, wait until you see the average Prosper portfolio.
I blame this more on the average person than Prosper. They publish historic default rates; I even wrote some quick simulation models before I put my money in. The biggest problem is that people see 20% and don't realize just -what- the C grade means.
I can't speak from the borrowing side, but the lending side seemed on par with the risk of the market to me. And for what it's worth, my Prosper portfolio did much better than my 401k.
I think the difference is that you are still the lender while a real bank just takes your money and does whatever it likes with it without even asking you.
On Zopa you decide that you actually lend 500 or 5000$.
This is an article which uses the popular 'hate the bankers' line to try and show something new.
I don't think the bankers with the big bonuses are going to get worried anytime soon. Banking is not really about personal loans and microfinance. If anything, banks do these things to keep customers coming in the door. The really big banks, the investment banks of the world, don't even do mortgages, because there's not enough scale. 50 million in loans isn't even the skin cells on the pimple on the bum of international banking. Until peer-to-peer finance can build a house, shopping centre or a bridge, I don't think those multi-million dollar bonuses are in any danger.
This is a bank, just with lower overheads and accordingly lower margins.
Thank you -- I see a lot of people thinking 'banking' is all about your personal small loan from the neighborhood bank. That's like a tiny slice of the tip of the iceberg.
Most banking takes place in volume, it is done through personal contacts, and it requires substantial knowledge and background in banking to do. Anyone who has ever managed a significant line of credit, term loan, or more sophisticated instruments used by larger businesses knows that you cannot just replace it with some peer to peer model.
This tiny slice is important. Disruption of industries starts at the bottom and the margins. Finance's lunch will be eaten by the internet or one of its successors sooner or later.
It could be argued that the mortgage market meltdown was only possible with modern computational and communication technology so in some sense, the disruption is already happening -- the i-banks couldn't keep their newly possible hyper-risk under control.
They even admit as much in the article... the headline was crap but thems the times we live in :-(.
Think about a credit card company that makes a credit line marketplace... consumer banking will see major shifts in the next decade (wild predictions!).
I am also not that bitter that bank employees are getting bonuses. There are probably some really smart people solving complicated problems there, they don't deserve to be punished because the government happened to bail out their employer. (They should have just let the banks fail, if this is such a big deal.)
Let's say you do a little side project for a friend's business. He agrees to pay you $1,000 regardless of whether his business succeeds or fails. To motivate you to put in more time and effort he agrees to pay you a bonus of %5 of the profits should his business double within the first year of your work completing.
Because of this percentage enticement you put in way more time and effort than you normally would for $1,000. However, his business fails completely and bankrupts him, despite your efforts. You don't get a bonus.
Now a reasonable person would understand that this is the risk you took with your time and effort. That you were only guaranteed $1,000. Any extra effort you put in was essentially an investment.
Let's say though that your friend convinced his neighboors that his business was essential to their well being and took up donations. Now instead of laying low and working hard to get his business back on track and pay off his neighboors, he start throwing bonus money around, most likely because he is also compensated via bonus money as president of his business.
The companies being bailed out are very large. Your example does not work because it presumes that bonuses are, or should be, tied to profitability or performance of the entire company.
Many companies wisely do not do this; rather they tie bonuses to the performance of business processes they are responsible for.
Suppose you work at a plumbing and carpentry business. You work for the plumbing division; an incompetent coworker works in the carpentry division. The coworker buys loads of wood for a client, but then lets it sit in the rain for too long and it rots. You have an employment contract that rewards you with a bonus for the performance in the plumbing business, which performs well. However, the loss of material causes the firm's overall profitability to turn to a loss, even though your division has reversed some of the damage of the carpentry division.
Should your bonus be reneged because of the carpenter?
Suppose you have a job offer at a competing plumbing business, and you decide that you will leave for that job if your current employer eliminates your bonus despite the contribution in profits you have made to the firm. Is the firm best served by eliminating your bonus?
Questions of bonuses for the CEO, presuming it was the CEO who presided over the disaster, are another matter: it's not clear why they should be rewarded by the board, given that they are ultimately responsible for all divisions.
This is a really good point and I'm actually familiar with the concept. It avoids profitable departments dragging along unprofitable ones in a large corp for extended periods of time (Pretty sure BCE is a good example of this).
So I can agree that handing out bonuses to a successful department while the rest of the company drags the entire bottom line down can be a very good thing.
However, here you have an unsuccessful business deciding to use their bailout money to keep who they believe are talented around by handing out bonuses. This reeks of mismanagement. There do exists companies that have tightened up their spending a great deal at the moment. Letting their employees know that they don't have extra coin to throw at them right now.
If you are a crazy talented banker, and have confidence in the company you work for, and agree that they deserved to be bailed out, then you wouldn't take a big bonus. You would rather it goes back into the business so you could gain higher returns down the road (like long term employment and future real bonuses).
On the other hand, if you are a crazy talented banker, and you have no confidence in your company succeeding, then you're probably going to take that bonus because you know you'll never see it again anyways.
A lot of the bank-bashing you see in the press is purely based on misconceptions of what banks do. The truth is that for small person-to-person loans of this type credit unions (and that's pretty much all Zopa really is by the way-a fancy-pants credit union with a website) have always been able to lend on lower margins than banks.
Now come to me when your credit union can give you a $50mm letter of credit to cover a shipment of goods from Brazil to China. In Portuguese and Mandarin, please, because the supplier and customer both want to see it. See, banks do all kinds of things that most people don't know or think about.
I think the only thing that's kept credit unions from doing that is size. If, and this is a huge IF, a credit union like Zopa can grow sufficiently large, it could do it.
These kinds of startups have an advantage for small loans, but for larger ones the "real" banks that don't have to carry all the money they lend (fractional reserve banking) have quite an advantage. Also, in a system where people loan directly from each other the money supply is constant. That's bad if you want economic growth, and I suppose, good if you're an environmentalist.
If you want to do away with banks you would have to somehow do away with the fractional reserve system. Any ideas on how to do that?
Things have to start somewhere. A new "financial system" will have to grow naturally to create any sort of stability, that is based on the trust in the system. And mind you your bank adviser is not really an adviser but a salesman. If you want advise on money use Mint.com.
There is nothing that hinders this kind of thinking to scale.
Microfinancing shows that there are money to be made in decentralizing where the money comes from and where they go to. It fit's perfectly into the "spread your investments" that seems to be the most stable.
To add to that, I actually think the future will bring much more small to medium sized companies than necessarily large organizations so it seems to be the right way to approach it.
Zopa acts here as a credit agency: they evaluate the borrower's creditworthiness but the lenders keeps the credit risk. What is their incentive to do this assessment thoroughly, and how are they going to get their credibility?
The idea of cutting overhead costs is good though, like you see with online banks.
Credit unions (not for profit) can be another solution to avoid banks. It is very popular in Ireland for instance.
You give your money to Zopa. Zopa divides it up into chunks and combines it with money from other 'lenders' and gives it to borrowers (which it has performed credit checks on). The borrower pays a fee, a part of which is given back to the lender. Also, if someone defaults Zopa goes after them.
How is this not a bank?