A few months ago, a venture capitalist asked my opinion about Zopa.com - a new financial startup. I told them I thought they were not much of a threat to banks. The VC went on to fund the company, which goes to show how little I know.

And as I learn more, I can see where I was wrong.

Zopa has been getting great press in the banking trade mags and the financial press. The company aims to be the EBay of banking - matching lenders and borrowers electronically with peer-to-peer technology.

My gut said this is a little gimmicky - slapping a little web 2.0 on a business where customers value local delivery. Banks discovered branch value when they tried to shut branches down 10 years ago. Since then, de novos (bank jargon for “new branch”) have skyrocketed. And much of the growth of the direct internet channel has come from cannibalized accounts or unprofitable rates.

But this is something new.

First, the neat side. Zopa really does apply internet thinking to our old-style business. They have created an electronic meeting place where borrowers can hook up with lenders, cutting banks out of the picture. They’ve applied some good ideas (credit scoring all of the borrower applicants, diversifying loans among a lot of people, handling collections). A Jupiter analyst tried a similar site and wrote about his experience.

Zopa charges pretty thin spreads (0.5% per year, plus a flat 0.5%) and has been careful to keep a straight business model. According to their website, depositors get higher rates and lenders lower rates than anywhere else (right now, they are British-only, but coming to America soon).

The spreads are so thin because Zopa cut out all of the regulatory hassles from being a bank, but also because they kept their model simple. They seem to be building their brand through online word-of-mouth and their marketing costs are de minimus (more jargon for “not a heck of a lot”). Marketing will go through the floor when zopa figures out viral marketing.

Credit losses have also been much lower than expected for the cohort (similar looking loans from the same time period). I’m no credit analyst, but I think these borrowers may skew to low default rate (power of a strong brand).

Next: the flaws in peer-to-peer banking

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