A LITTLE-known person-to-person lending exchange has seen increasing numbers of savers, unhappy with the derisory interest rates offered elsewhere, join up in the last month.

A LITTLE-known person-to-person lending exchange has seen increasing numbers of savers, unhappy with the derisory interest rates offered elsewhere, join up in the last month. Rather than lending its own money, London-based Zopa works by matching savers to borrowers. It lets savers set the interest rate at which they are willing to lend, which becomes the rate that borrowers pay for their loans.

The exchange is currently giving an annual return of 9.1% gross after charges. When tax is factored in that still works out at 7.28% for basic-rate taxpayers and 5.46% for higher-rate taxpayers; almost 4% and 2% more than the best-paying cash ISA was offering last week.

Zopa says it arranged £1.2 million of loans between its members in December 2008, up more than 140% on the same month in 2007. But unlike savings held in a bank account or cash ISA, money loaned through Zopa is not protected by any government compensation scheme. If something goes wrong there will be no protection fund to bail them out.

Zopa counters that because of the way it parcels up its members' money before lending it out, the risk of not getting it back is minimal. It divides up money from lenders and combines it with money from other lenders, so someone lending £500 would, in fact, lend £50 to 10 people, and not £500 to one borrower.

The firm claims to further reduce risk by only lending to the most prime of prime borrowers. All borrowers are identity checked, credit scored and risk assessed. Even if someone has a good credit rating, if they fail to meet Zopa's strict affordability standards they will not be accepted for a loan.

It also matches savers to borrowers, so it should avoid the UK banks' problem of lending more money than they had, even though lenders need to be clear that, in theory, they could lose all their money.

The scheme's current default rate is just 0.2%, but not everyone is happy. Even though saver/lenders have been willing to lend to 20-somethings at rates of up to 12.8% (pre-tax), some potential and past users on Moneysupermarket.com and Moneysavingexpert.com lament the lack of presence of desperate borrowers willing to agree to their demands for an even higher return.

Giles Andrews, Zopa co-founder and managing director, said the company is now working towards making its lending tax-free. He said: "Inland Revenue rules allow Zopa lending to be sheltered within a Sipp already, but there is work required on administration systems before this could go live. We are also lobbying the government to allow Zopa lending to be included within an Isa."