Zopa safeguard - no bad debt = good option?

bowlhead99

winniethewoo wrote: »

Zopa is still worthwhile for diversification. If you have say 10k in savings, its quite wise to loan £5000 to hundreds of small borrowers via something like Zopa and "loan" the remainder to a financial institution by opening a savings account

I agree diversification is generally a good thing to spread risk.

However in this example you're suggesting we give up the solid guarantee of 100% insurance on £10k deposited cash, provided by the financial services compensation scheme which is backed by the entire financial services industry (and one suspects, within reasonable limits, by the government in the name of consumer confidence), and replace half of it with a bad debt deposit coverage scheme operated by Zopa or the like, which per their T&C is not guaranteed to pay out and does not have industry- or government-level support.

Sure, you can chase superior returns by investing in unsecured loans to people who can't or don't want to use their own savings to finance a new car or whatever. After the middleman takes his cut, you will get a better headline interest rate than depositing in a savings account. Because it's more risky.

If you're using the analogy that money deposited with a bank is an "investment", the money with the bank is ultimately invested in hundreds of thousands (or millions) of loans, credit cards and mortgages which is very much more diversified than the few hundred extra underlying accounts you get by also putting £5k with Zopa. The problem is the bank takes a very large "management fee" before giving you back the deposit with interest and like Zopa the bank might go bust. But there is a superhuman level of insurance on you losing money from a bank deposit.

So if you want more direct access to the borrowers, you can go with Zopa. But I'd say you are surely "diversifying" to 'chase higher returns', rather than 'to limit downside risk and tend towards a more average return', which is the more normal reason people use the phrase "diversify" in an investment context.

If you want a portfolio of consumer debt with some of the income used to provide bad debt protection insurance, then fine, but making it accessible to the masses by having a nice easy website does not turn it into a high-rate-savings-account equivalent that you should just recommend we hop into to protect against our bank going bust. You should only compare it with other true investment options (which can often be held in tax free wrappers like ISAs or SIPPs) and look at the returns.

Long story short, I echo Jamesd's sentiments on this I think.

winniethewoo

Thanks jamesd. I didn't know the FCFS had paid out to smaller credit unions etc that you mentioned in your post. I swotted up on the Icesave case on wikipedia. It seems extremely complex, with the decision to compensate retail investors not necessarily a given despite the government guarantees, both in Iceland and the UK.

By never been tested, I was referring to an article in the FT I read, which went into some detail explaining that should many banks go under, nobody knows where the money to compensate everyone will come from. At that point in 2009, until it almost happened, a system wide meltdown wasn't thought possible and hence there weren't enough funds available to the deposit guarantee system to repay everyone. I don't know if this has changed (something else to swot up on!). In this sense, its still wise to diversify away from banks.

@bowlhead99. I disagree. I think its much LESS risky to lend say 5k unguaranteed to hundreds of people with good credit ratings on Zopa etc, that "invest" it by opening a savings account in a bank. I think the "markets" in this regard have mispriced risk. I don't know if you saw the BBC documentaries on banking recently? The banks are far from reformed. As a whole, especially in Europe, they are still far away from being stable, self supporting entities. I will try and dig up some articles in the weekend that argue this case.

However, I guess if there was enough money in the deposit guarantee system to compensate everyone should MANY banks go under, my arguments are invalid!

grey_gym_sock

most of the complication with icesave was to do with iceland not being keen to bail out UK savers. you can avoid that by sticking to a bank operating in the UK under the UK FSCS (that includes some UK subsidiaries of non-UK banks).

the government has lent money to the FSCS before, and been gradually repaid by FSCS levying the banks. so that's likely to happen again, if the FSCS has an issue with needing more cash in the immediate term than it can raise. things would become more doubtful if the FSCS needed more cash than it could plausibly expect to recover from all the banks left standing. so it comes back to the solvency of the entire banking system.

however zopa may rate their borrowers, it is rarely sensible to borrow except for mortgages or student loans, so i would question the competence of the average zopa borrower at managing their own finances. which makes lending them money riskier.

if you want to lend to genuinely low-risk borrowers, put your money in a building society account, where it will mostly be lent on mortgages. the returns are lower, but for a reason: it's lower risk. (and the building society's costs will be lower than zopa's, given the much large average loan size.)

pqrdef

jamesd wrote: »

If you're considering Zopa at only 5.1% and not already using things like the First Direct regular saver that's paying 6%

Maximum balance less than £2K average? A toy account. Zopa is for when you've maxed out the itsy-bitsy stuff.

jamesd wrote: »

It's also easy to get more than 5% tax free inside a S&S ISA.

Also limited as to what you can put in. But more importantly, the capital value fluctuates. Within the last couple of weeks a senior BoE guy has been talking about Bernanke bursting the bond bubble, so the yield on bond funds is hardly the main issue at present. It's more about timing your exit.

jamesd

winniethewoo wrote: »

nobody knows where the money to compensate everyone will come from. At that point in 2009, until it almost happened, a system wide meltdown wasn't thought possible and hence there weren't enough funds available to the deposit guarantee system to repay everyone.

There isn't any significant amount of money in the deposit guarantee system. That's not quite how it works. When the FSCS needs lots of money it borrows it from the Bank of England as a loan. Then it charges a levy on financial firms and uses the levy money to repay the loan over many years. So there's as much money available as can be funded by the BoE borrowing and levy paying firms.

For bigger cases there were the RBS and Lloyds rescue deals, where instead of being allowed to fail, the banks were partly nationalised. Each of those deals is likely to be profitable for taxpayers unless a government makes a political decision to sell before the profitability point is reached. The profit comes because the government nationalised at an impaired credit price but can sell later at a price with less impairment. The rescues were cheaper than allowing them to fail then paying compensation.

For very large scale failures where even more banks needed rescuing it's possible that the government might not be able to rescue them, something that happened in the Cyprus case, where the banks were too large compared to the size of the economy and government credit rating to make a simple rescue possible. That's not particularly likely in the UK because of the relative sizes of the banks and the credit rating of the country. But it's not completely impossible, which is part of why banks are being made to hold larger reserves.

winniethewoo wrote: »

@bowlhead99. I disagree. I think its much LESS risky to lend say 5k unguaranteed to hundreds of people with good credit ratings on Zopa etc, that "invest" it by opening a savings account in a bank.

That's what the banks do, lending to lots of people with a range of credit ratings. But unlike the P2P case, the banks and their shareholders and bondholders take the credit risk, not us. That's inherently less risky for us, particularly when backed up by the FSCS protection.

There are also a range of risks, like P2P business insolvency or fraud or failure to follow credit scoring policies. All of those have been seen in various credit businesses over the last few years. There's also the lack of appeal to FOS and currently lack of an investment regulator, which in part shows up in advertising that would be completely unacceptable if it had been carried out by a business regulated by the FCA. Things like claiming to existing investors that the Safeguard system is risk free, when it isn't. Such misleading promotions are another of the risks - investors might believe the claims and invest believing it really is risk free. In the wider investment world there have been a number of nasty incidents in recent years when investments were portrayed as less risky than they really were, some of which resulted in some of the FSCS payouts in the intermediary list.

This doesn't mean that P2P is bad, just that it has its own risks and those need to be considered as well. I'd happily use Zopa's non-Safeguard system in the future if I could get a rate I thought was worthwhile. Though the way it's promoting Safeguard with inaccurate risk descriptions is discouraging, suggesting that it's still not acting as a regulated financial services business should. It'd be really nice if it did as well here as it does on its credit underwriting!

At the moment I'm mostly using isePankur instead. Bad debts are likely to be higher there but since I'm lending at 28% or so there's some margin for that. Time will tell whether it's sufficient. isePankur adds mandatory tax return filing (foreign interest received) and foreign exchange and just generally different law risks to those of the UK-based P2P firms. But it has one significant advantage, it's doing interest rate arbitrage between the rest of Europe and a country where normal lending rates are around that 28% level. So here we can get low rates but there we can lend at higher ones, with the chance of both us and the locals benefiting from the difference in rates between countries. If it works it'll be really fulfilling some of the great promise of P2P lending, with the large difference in interest rates allowing the P2P company to make money as well. Like all P2P this is high risk in investment terms but it's higher risk than the domestic firms and definitely not for widows and orphans!

jamesd

pqrdef wrote: »

Maximum balance less than £2K average? A toy account. Zopa is for when you've maxed out the itsy-bitsy stuff.

winniethewoo was writing about a total of £5,000 to invest or save. There are enough regular saver and other options to do that without trouble.

Once the whole ISA allowance of £960 a month, £11,520 a year, has been used it's worth looking at other things, though with good attention paid to the risk tolerance of the investor. Some of us do have enough money around to benefit from such things but for most, that ISA allowance will be all of the non-pension investing they can do, and more.

Others might have large lump sums. Then things like diversification can matter and with a standard recommendation of no more than 5% into one investment, that might be the limiting factor for P2P use for some.

P2P is interesting and I like it, though.

badger09

jamesd wrote: »

Some of us do have enough money around to benefit from such things but for most, that ISA allowance will be all of the non-pension investing they can do, and more.

Others might have large lump sums. Then things like diversification can matter and with a standard recommendation of no more than 5% into one investment, that might be the limiting factor for P2P use for some.

P2P is interesting and I like it, though.

Not as 'interesting' in more than one sense of the word, as it was in 2006, 2007, 2009, or 2010 though

P2P investing should definitely not be compared to savings accounts, and is much higher risk than most of its lenders/investors realise :cool: