Platforms are innovating and adapting in order to survive the current crisis. Michael Lloyd asks how risk mitigation has evolved during the pandemic
The peer-to-peer lending sector is facing choppy waters after a year of the ongoing storm that is the Covid-19 crisis. Platforms’ risk mitigation has been put to the test like never before, as the sector has weathered its first downturn.
And while there have been some failures, there have also been many examples of P2P lenders adapting successfully to current conditions. Now, as we enter what is hopefully the last phase of the coronavirus pandemic, innovation is returning. Luckily, this is one of the things that the sector is best known for.
Many platforms have been lending more cautiously during the crisis, but now they are developing new tools and processes to improve their risk mitigation. P2P property lending platform FutureBricks has placed its focus on the accuracy of the information used to assess risk. With this in mind, the platform introduced a loan risk categorisation scoring system in February this year.
“FutureBricks’ processes now validate the quality of data used at input and risk assessment output to ensure risk is fully understood and handled appropriately,” says Arya Taware, managing director of FutureBricks. “FutureBricks is currently using a number of new and innovative software models throughout our underwriting and loan management functions which considerably help the speed and accuracy of the assessment process.”
Similarly, asset-backed P2P lending platform Ablrate is developing a risk score for its investors. David Bradley-Ward, chief executive of the platform, says the system will look at an investor’s portfolio of loans and give them a score out of 100 as well as tips on how to improve their score in the future.
“If you have £100,000 on the platform and one loan paying 15 per cent, that’s not diversified and is risky, so you’d get a low score,” he says. “If the score’s below 30, it’d say ‘you’re in the risky band and might want to diversify and this is how you do it, go onto the secondary market and buy other loans’. The more diversification, the higher the score.
“And if a business you have a loan for is asset-backed it may have a high score.”
Read more: Asset-backed P2P lending: Put to the test
Atuksha Poonwassie, managing director of property investment platform Simple Crowdfunding, views this as an interesting concept but suggests that it could be challenging to implement because investor profiles are so different. She says her platform is currently conducting an internal review into risk mitigation to see if there are any improvements it can make.
“It’s good practice to do a review every so often anyway so it makes sense to do that for our business to help further mitigate risk if there are viable points to consider,” Poonwassie says. “We do an internal review every so often to look at policies and procedures and at the moment part of that is looking at risk mitigation and credit list segments.”
Some platforms are using technology to streamline their processes, which can benefit their risk mitigation.
Peer2Peer Finance News knows of one platform working on implementing a new technology system to improve efficiency. Furthermore, Assetz Capital is currently undergoing major improvements to its processes, by implementing system enhancements to streamline its bridging loans.
“Streamlining can help with risk mitigation or make it worse,” says Stuart Law, chief executive of Assetz Capital. “You want it faster and slicker and driving risk out of the system by improving your processes.”
As well as developing new technology, P2P platforms are well known for using software and APIs which have risk mitigation systems already in place, some of which are powered by open banking. The data-sharing initiative is hugely beneficial for risk mitigation.
Using open banking to view transactions in real-time, rather than uploading pdf documents of bank statements, reduces the risk of fraud and gives lenders a more accurate picture of the affordability of borrowers. But despite these benefits, only a handful of P2P platforms are currently using open banking.
These include, but are not limited to, ArchOver, Lending Works, Leap Lending – which launched at the start of last year with the requirement of only lending to borrowers that use open banking – and Rebuildingsociety, which implemented the data sharing initiative for itself and its appointed representatives during 2020.
“TrueLayer’s open banking is working well for us, people can deposit money onto the platform using open banking,” says Daniel Rajkumar, managing director of Rebuildingsociety. “It gives confirmation of the payee and we get direct access to bank statements when we used to rely on people uploading pdfs. Now it’s bank-to-bank which is more reliable and the confirmation of payees works well to mitigate fraud.”
It’s worth noting that technology can aid risk mitigation, but this needs to be underpinned by manual work and processes, such as quality underwriting.
These have certainly been tested during the tempest of Covid-19. Rising default rates and increased investor redemption requests have served as thunder and lightning to the sector, forcing platforms to adapt and get their houses in order. As a result, the majority of platforms have become more cautious and risk adverse, tightening their lending.
Although it differs from platform to platform, by and large they have been reviewing their processes and keeping in regular contact with borrowers to ask how Covid has affected them and whether they have taken government support, while steering clear of riskier sectors such as the hospitality and leisure industries.
On the investor front, platforms are regularly updating lenders on projects and what they are doing. As a result of the pandemic, Folk2Folk has made some adjustments to its sector appetite, application forms and portfolio review.
“Changes include having a new stage in our application review where we include information about how Covid has impacted any potential borrower,” says Roy Warren, managing director of Folk2Folk. “If necessary, this may lead us to limit the loan-to-value on any borrowing we agree to proceed with. We are always vigilant to changes in borrower circumstance and the external environment, but even more so now.”
However, there is some disparity between platforms’ approaches to changing risks, with some undergoing lots of changes and others making no changes at all. Money&Co was already ensuring it had proper security on its loans during 2019 and its approach has remained the same since, as chief executive Nicola Horlick was already concerned about the UK economy due to Brexit.
Furthermore, while Simple Crowdfunding has been asking investors and borrowers if their circumstances have changed, its core risk mitigation has remained the same due to downvaluations. “We do first charge lending on P2P loans based on current values and the valuation reports are already cautious,” says Poonwassie. “The valuations themselves have come down during Covid so that work has already been done. Downvaluations are not generally a good thing for us but take into consideration market conditions.”
Rajkumar says that as a principal platform, Rebuildingsociety has made significant efforts to improve the framework it operates within in light of appointing representatives. He adds that P2P lending is a sector that aligns risk and reward for investors, so the platform provides information to lenders to make educated judgements on investing.
“Platforms need to make a serious, concerted effort to understand and mitigate risks for customers and give information to them to make informed decisions,” he says.
“Rebuildingsociety has always been a conduit platform airing on the side of providing more information and this has worked well for those that understand the risks and for those that don’t, the appropriateness test is there.
“During Covid there’s significantly more risk and appropriate investors take the time and care to understand the macro-economic climate.”
As Rajkumar says, during Covid there are more factors that platforms have to consider, which in turn introduces further risk. Platforms and industry stakeholders clash on the topic of whether the sector’s risk management is currently fit for purpose.
Some point to the obvious recent examples of The House Crowd entering into administration and the permanent closure of Octopus Choice, and say improvement is needed. One thing is for certain, platforms are improving and at the end of the pandemic, the survivors will have demonstrated their successful risk mitigation during the sector’s first economic downturn.
“We’re in a scenario we did not directly envisage,” says Mark Turner, managing director, regulatory consulting at business advisory firm Duff & Phelps. “There are a number of risks platforms are having to deal with at the moment. Financial risk to their businesses may have been impacted by the sudden change of environment. Firms have had to take action in terms of risk oversight and mitigation.
“Lots of the firms I talk to in the sector are keeping on top of things, a number I talk to have been able to demonstrate their business model has been resilient and fit for purpose.
“For those firms coming out of the other side of this crisis in a good state, it definitely is a demonstration that their business is strong.”
P2P platforms have faced their biggest-ever challenge over the past 12 months and have had to innovate and adapt to address unprecedented risks. It is vital that these platforms stay ahead of the curve and continue to prioritise their risk mitigation processes as the storm starts to show signs of abating.