How should banks react to the Social Lending phenomenon and keep their clients from leaving? A relevant question since the popularity of social finance companies like Zopa, Prosper and Smava is rapidly increasing.

Companies like the internet-based Zopa allow members to lend money to and borrow money from other members, cutting out banks as the traditional middle man.

In a sense, Zopa acts as a market place, matching people that want to make (small) investments with people that want to borrow money. It’s like borrowing money from friends and family, except there are thousands of people you can borrow from or lend to.

Better rates
A spokesman of Zopa says both Zopa-lenders and borrowers get better rates, because Social Lending is more efficient than the traditional banking model. “Banks have massive overheads, with thousands of employees to pay and hundreds of branches to maintain. So they have to take large margins on the money that passes through them. An online marketplace where people meet to lend and borrow has huge cost advantages – which is why Zopa members get a fairer deal when it comes to their money.”

“Further lenders and borrowers of Zopa have nothing to do with unethical investments of banks. So Social Lending is a smarter, fairer and more human way of doing money.”

Growing business
Giles Andrews, Zopa’s chief executive, said last monday in The Independent its business grew rapidly in the second half of last year as bank lending prices rocketed while savings returns tumbled.

He said that in the second half new members “with an appetite to lend” rose 81 per cent from a year earlier and loans paid out increased by 78 per cent. In January 2009, new lenders were up by more than 700 per cent and the amount of money lent rose 109 per cent. Each month since July has seen about double the lending of a year ago.

How to deal with it?
Last year, Zopa was voted ‘Most Threatening Non-Bank Competitor’ by Retail Banker International. So how should banks deal with this threat? Perhaps they can try and incorporate this new lending system into their own business model. Keep the basis of the concept, people directly investing into other people with good interest rates for both parties, and add their own value. With minimal effort, a bank’s infrastructure can be used to make the process run more smoothly. And for those investors who would like a little more security, and don’t mind a little less interest, banks can step in and back up the investments with their own capital.

So what do you think? A disruptive opportunity for banks, or a concept that banks should steer clear of?