By Mike Baliman on Thursday 24 September 2015
Let’s get into the spirit of stress testing by considering your economic life. Let’s assume that in the current fair weather macroeconomic conditions you are keeping your head above water.
So what would happen if the economy turned sour?
Good point – so here is the first question to ask your P2P – “Have you done a stress test?”
And if they reply “no” ask them what kind of sailor doesn’t check whether his boat can handle bad weather?
Or more prosically “so how can you tell investors what their downside is?”
At which point you might ask … “how sour?”
Good question, well-presented. And the answer to this question is that the Bank of England has gone to great lengths to define both fair and foul weather macroeconomic scenarios – so that’s a good benchmark – not least of which is that it's what all banks have to use to run their own internal stress tests.
So in your case perhaps one of the main parameters is your house price – which in the BoE bad weather stress test would fall 20%.
I’m sure you could do that arithmetic in your head. And bingo you have done a stress test. It’s a simple one but it still is one.
So the second question to ask your P2P platform if they say they have done a stress test is “what quality”? “Cheap and cheerful” or “in depth and hard work”?
Of course we can assume that no platform would say the former – they would of course spin it in the modern way. However the truth is that only Funding Circle (2014) and Landbay (2015) have “gone all the way”.
But what is “all the way”?
Let’s continue with you.
Doing the property calculation in your head was easy. But now it gets tricky. You notice the Bank of England stress test maps out a recession. Will you lose your job for example?
Hmm hard to say isn’t it, as there is a very weak correlation between GDP and your job. You need to make some modelling assumptions about the interconnections.
At this point you do one of two things - either an “internal stress test” or an “external stress test”.
In the former case you decide (“model”) it yourself. The trouble with that is you might be biased towards the optimistic side. You might think one thing but if I ran the numbers I might independently decide another.
So the third question to ask your P2P is “did you do the stress test yourself or was it done independently?”
And perhaps take the DIY job with a large pinch of salt.
The final point in understanding the whole market dynamics of stress testing P2Ps is who conducted the exercise. In the above case I stress tested your portfolio. But I am not an expert.
So the fourth question is “who conducted the stress test and what are their credentials in your market segment?”
This last question isn’t as trivial as it seems. P2P covers a very wide range of assets these days and no firm can, by definition, be the go-to experts in each asset category.
If you want to dive a little deeper into Stress Testing P2P portfolios check out the latest London Fintech Podcast – LFP035 where John Goodall, CEO at Landbay, takes us through their recent external exercise in modelling the impact of the BoE’s bad weather scenario on their business.