P2P Lending, Loss Rates, and Risk Mitigation

It's been almost a decade since the first UK P2P Lender Zopa launched, back in April 2005. In the analog world, relationships mattered. In a digital one, it seems data is the only thing that matters. And for small business, a crowdfunding or P2P platform plays the role of the trusted intermediary to conduct business, supplanting the banks.

I spoke to the Asian retail banking head for one very large global bank. His comments about all this were interesting, and are summarized below:

  • What compels the customer to pay money back other than reach of law?
  • There is no relationship business with the borrower to create loyalty to get greater insight of needs or ability to pay.
  • What is the difference between a quality lending business and one that is not? Do we know the customer, do we have a relationship with the customer, does the customer care what we think, what is the profile of the customer, did customer seek us out or did we seek them out? These all matter to me.

Sure you can go out and get data from credit agencies to feed scoring models. You can also get business date from Facebook, Yelp, and other borrower self-generated data.

So what about losses? Chris Skinner, Chairman at the Financial Services Club and author of the Digital Bank, pointed out in a recent post the default rates at Zopa and RateSetter have been 0.69% since launch, and 1.5% at the higher-risk SME lender Funding Circle. All in all, losses are very acceptable and much better than credit cards. But we have been in a benign credit world, one flush with government money and very low interest rates and we cannot overlook underwriting standards.

What is interesting is the risk mitigation techniques and underwriting standards used to manage bad debts. This matters to investors.

Here are how two different P2P lenders deal with late payments, courtesy of Chris Skinner.

Zopa (P2P lending):
At Zopa, if a borrower misses a repayment, a collections team chases on your behalf. But if a borrower reaches a point where they are behind on their loan repayments by at least 4 months, we’ve created the Safeguard fund to step in and give you back your money, including interest owed. It’s funded by a contribution from the fee a borrower pays when their loan is approved. As you can see, there’s a buffer on top of what it expects to pay out. The Safeguard fund has covered all bad loans since it launched. This means not a single lender has lost money on loans covered by the fund.

Funding Circle (SME lending):
Every business on Funding Circle has been assessed by our experienced credit team. They are established and creditworthy and have typically been trading for around 10 years.

It appears Zopa has a bit more cushion for investors then Funding Circle.

The issue these sites have is they co-mingle investors to make loans. A loan is a single unit that is in effect owned by multiple entities. So a critical question for investors is that you own half and I own half what happens if there is a loss?

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