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How I Opened My Own Bank!

By Cliff D'Arcy
April 6, 2006

Have you ever heard of the "three-six-three" rule of banking? It's quite simple: pay savers 3% before tax, charge borrowers 6%, and be on the golf course by 3pm!

Although this quip is a little tongue in cheek, it does sum up the heart of retail banking very simply: pay savers far less than you charge borrowers and you make big profits. Indeed, with the Bank of England's base rate at a historically low level of 4.5% a year, lending money on credit cards at an average annual interest rate of over 15.5% is a licence to print money!

Alas, the banks (and to a lesser degree, the building societies) have an iron grip over lending to individuals in the UK, and that will never change, right? Wrong -- and to prove it, I set up my own bank earlier this year!

What I did was become a member of Zopa: the world's first online lending and borrowing exchange for individuals. Zopa harnesses the power of the Web to introduced lending members (people with spare cash) to borrowing members (people who want a personal loan). So, instead of saving or borrowing from a bank, you can lend to, or borrow from, a large group of individuals. Of course, Zopa represents a threat to the banks, because, being a peer-to-peer exchange (think of it as "eBay for money"), it completely cuts them out of the lending/borrowing equation.

Zopa was launched over a year ago and now has 60,000 members, so it has developed into a mature and liquid market for exchanging cash. Indeed, it's been so successful that it's being copied all over the world and is set to launch in the US later this year. Zopa is regulated by the Financial Services Authority and the Office of Fair Trading, and its founder, Richard Duvall, also started Egg, now the world's largest online bank. Furthermore, Zopa is backed by the founders of two massively successful Internet businesses, eBay and Skype.

Some financial commentators have gone so far as to describe Zopa a completely new asset class, to be ranked alongside cash, bonds and shares. Indeed, you can think of it as a "bond market for individuals", where one person raises a large amount by borrowing smaller sums from lots of others. Hence, savers and investors can use Zopa to diversify their portfolio beyond the usual assets (cash, bonds, property and shares) by becoming a lender.

As you can tell, I'm quite a fan of Zopa -- so much so in fact, that I've set up "BankOfCliff" and have been lending money throughout March. Although I love the socially responsible idea of saving borrowers from the greedy banks by lending to real people, I'm also happy with the returns. Indeed, they should comfortably beat the 5% before tax that I'm earning from keeping cash on deposit.

According to Zopa, the average gross (pre-tax) return to lending members is 7% a year and, thanks to almost zero bad debt, Zopa lenders are earning even higher returns than they'd budgeted for. Zopa lenders can lend between £10 and £25,000 over periods from six months to five years. And, naturally, all borrowers are properly identified and are subject to the same credit checks used by the banks.

In fact, it's been great fun watching BankOfCliff in action. During March, I lent money to a hundred different real people across the UK, from Aberdeen to Portsmouth, including two people from my borough. My borrowers (three-quarters of whom are male) range in age from 28 to 61, with an average age of 42. Most needed a loan to pay for a car or home improvements, although one borrower planned to use the money for a wedding (aaah, bless!).

Now for the financials: you choose your level of risk, so I lent money at annual interest rates of between 4.6% and 8% to both "A" and "B" rated borrowers. However, all of these loans attracted a 2% lenders' bonus from Zopa (this special offer has been extended throughout April), boosting my returns to between 6.6% and 10% a year before bad debt write-offs. Furthermore, I received two bottles of Fairtrade wine for lending more than a grand, plus £30 for introducing a friend as a Zopa member. Not bad, huh?

So, how does Zopa make its money? It earns commissions from the sale of payment protection insurance, plus it charges borrowers a fee of 1% of their loan. However, from 5 April, borrowers will pay an upfront fee of 0.5% of their loan (which comes to £25 on a loan of £5,000) and, from 12 April, lenders will pay an annual fee of 0.5% of their outstanding lending, which will be calculated and paid monthly.

So, if you want to join Zopa as a lending member, getting in before 12 April will mean that you avoid paying annual fees, so don't leave things to the last minute!

Finally, if you're wondering about the weird name, Zopa stands for "zone of possible agreement", which describes the overlap between the highest price that one person is prepared to pay and the lowest price that another person is prepared to receive. Hence, without this Zopa overlap, you can't make a deal!

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