Someone’s measuring risk in P2P
Where does virtue come from? It’s a good question and in the world of Finance - old, new and alternative - just as in the worlds of healthy eating and going to bed early the rejoinder is generally “Lord make me virtuous but not yet”.
In the wild west of the early days of online lending and borrowing everything was thought possible - even the idea that the platforms might actually communicate levels of risk to investors. Or that after years of regulatory scrutiny this might be pressed upon them. Historians of the Fintech boom might be directed to a couple of dozen articles I wrote in 2015 for this esteemed journal.
For the rest of you lets KISS. What matters to you if you stick a grand in a platform is how much you might get back in a year's time, or three years' time or whatever it is
So lets say you gave it to a P2P platform which was doing this right. Then depending on how much risk you were running in the loans and how diversified your investments the platform might say “in almost all cases you should end up with between £1,050 and £1,250”.
To give another example the range might be on another platform “£850-1,400”. Or if you are crazy enough to bet it all on one loan then “£0-£1,300”.
It’s no different from betting on the horses. You place a bet, you know your worst case and your best case. And (though this isn’t what the general public does) if you bet say one thousand £1s on one thousand horses then statistically speaking you are “never” going to lose 1,000 times nor will you win 1,000 times so your likely return will be (say) £500-£1,500.
Quite simple really. Risk is the uncertainty of outcome. Even the principal source of first time buyers' deposits - the Bank of Mum and Dad - would understand that one.
That is perhaps unless Mum or Dad worked for a P2P in which case they wouldn’t. Or couldn’t. Or thought it in the best interests of their VCs not to. Future historians with a side interest in how one can make car crash youtubes out of shooting p2p fish in a barrel might like to check out the Lendit 2015 Panel on Risk. Those of you prone to bad dreams might give it a miss.
So instead of the KISS, we had provision funds which kept Kadhim Shubber off the streets or we had letters A, B, C - I guess at least such platforms are to be congratulated on not using the Cyrillic alphabet. Perhaps both of these were better than the other well-chosen option of “nothing”, though you tell me what A and B actually mean.
Anyway successful Finance - old or new - is all about “the route to the loot” and increasingly those paragons of virtue the credit rating agencies were diving in there, rating packages of loans. So finally a professional, independent assessment of risk albeit only relevant to institutions. Quite laudable for those whose memories stretch less than a decade into the past history of rating agencies' triumphs.
At which point one might have thought your Mum and Dad who run P2Ps had got away scott-free and that like oldskool Finance back in the day no one actually bothered to quantify risk.
So it was quite a shock at Lendit 2017 when Rupert Taylor stood up and announced an index of not just risk but risk compared to return. Not just what it is today but how it has tracked over time, how it varies between players and even between continents.
If it's not quite “how much am I risking losing here?”, it’s at least explicable to your Mum and Dad - even your Mum and Dad in P2P. They’ll get the idea of how many times the interest they are getting covers the recent pattern of losses on a platform.
So it’s good to know for example that you are getting say 6 per cent net interest and your platform's recent losses are 2 per cent. Curiously for one schooled in banking Rupert has slipped into insurance speak in calling it the ‘loss coverage’ ratio (in this case 3x) but we can't have everything.
It doesn’t tell you about the future but if you glue yourself to the screen closely enough it is a seismograph and it can compare platform A against platform B. Or, capitalism being what it is, maybe you can if you pay for a subscription which provides a deeper dive.
It also has the merit for those amongst you who can tell your GIGO from your go-go of being based on cleansed data.
The Amalgamated Union of Risk Professionals may well quibble - for what else would they do, not quibbling would render them unemployed - on matters such as duration drift, not subtracting the risk free rate, and that the real risk in a loan is doubtless represented by the rate the borrower pays not that rate minus who knows what level of fees and provision fund bung.
But this is to miss the point.
Finally we have V1.0 of something – and well-considered and well-executed at that.
And so back to where virtue comes from?
Curiously it comes neither from the trade association (of some P2Ps) the P2PFA nor does it come from the FCA despite years on the case.
This is kinda odd other than it’s the zeitgeist. As Lord Turner, the last head of the FSA has said: “we need a small number of powerful regulations rather than micro-supervision”.
Meanwhile some discover virtue on their own. In the UK Zopa,Funding Circle,Ratesetter, MarketInvoice and Assetz Capital are on the roll of honour.
I wonder when the rest will join?
