Innovative Finance ISA Glossary
AML stands for Anti-Money Laundering. These checks form an important part of the Peer-to-Peer lending platform’s client identification checks, which are compulsory and which are carried out for both borrowers and lenders. AML checks help prevent ID and financial fraud as well as money laundering, and will typically require the would-be lender or borrower to provide proof of ID and address.
A way of expressing a return on investment (in this case, a return on money invested into Peer-to-Peer loans) as a yearly value, even where the returns may not directly pertain to a full calendar year. To illustrate, if a Peer-to-Peer loan delivers a 1% interest return in the first month, this can be recalculated to an annualised interest return by multiplying the interest by 12 months, giving an annualised return of approximately 12%. Annualised returns are often only hypothetical projections, and actual results may differ.
A legal term describing a situation where the borrower’s Peer-to-Peer loan repayments become overdue, whether in full or in part. Where a repayment obligation goes into arrears, some platforms will impose additional fees on the borrower.
A legal term and status whereby a person or company who is no longer able to make good the amounts it owes to creditors is declared bankrupt under a court order. If a borrower is declared bankrupt, the Peer-to-Peer lending platform which originated the loan may have a procedure in place to appoint an Administrator to seek to recover the funds or, in the case of a property-backed loan, the property itself may in some cases have been ringfenced to protect the lender in the event of borrower bankruptcy.
Borrower Type / Loan Type
Different Peer-to-Peer lending platforms lend money to different borrowers. The three main uses of loans are property loans, consumer (personal) loans and business loans. Whilst some platforms specialise in one loan type, many platforms lend across multiple different borrower types.
Loans that are made available to individual borrowers, as opposed to loans which are made to companies. Certain platforms provide only consumer credit, others provide exclusively commercial finance; many platforms provide both.
Credit Risk Grade / Risk Banding
Credit risk gradings are a form of credit scoring – a means of ranking a potential borrower’s creditworthiness. Risk grades are determined by the Peer-to-Peer lending platform based on their analysis of the borrower, and will usually be derived from the individual borrower’s credit history.
A business that is considered low risk may be categorised into ‘Risk Band A’ while a business of high risk (i.e. higher possibility of not being able to make loan repayments) could be categorised as ‘Risk Band E’.
There is no set industry standard for credit risk grading, meaning that it can be difficult to compare risk between platforms on a like-for-like basis.
A central ‘hub’ page within the Peer-to-Peer lending platform’s website which provides the lender with a high-level overview of their Peer-to-Peer lending activities, including key performance metrics.
A borrower is said to have defaulted when it fails (for any reason) to meet its repayment obligations – such as missing a monthly repayment instalment. Default rates are generally used to measure the average rate at which borrowers are expected to default across a given Peer-to-Peer lending platform. Default rates are generally derived from historical data and therefore cannot be used to predict the future default rate of a platform with any certainty.
After a lender deposits (or “uploads”) funds into a Peer-to-Peer lending platform, these funds will not always be immediately lent out to businesses – particularly if the lender is holding out for a higher interest return. Funds that have been both deposited into a Peer-to-Peer lending platform and then subsequently lent out to borrowers by the platform are referred to as having been ‘deployed’.
Interest is generally only earned on funds that have been deployed. Funds which have (for whatever reason) not yet deployed will typically earn no interest.
Diversification of Risk
Within Peer-to-Peer lending, diversification of risk is the concept of spreading loan capital across a large number of different borrowers, in order to minimise the impact to the lender of any one borrower defaulting on his or her repayment obligation.
Within investing generally, diversification of risk extends to ensure the investor’s capital is adequately spread across multiple forms and types of investment.
Where a borrower repays its Peer-to-Peer loan ahead of the agreed loan terms. Some platforms allow borrowers to make early repayments to their loans without any fee implications; others invoke additional fees on the part of the borrower to make up for the lender’s loss of interest income.
Financial Conduct Authority (FCA)
The Financial Conduct Authority is the UK’s key financial regulator and has since April 2014, regulated the Peer-to-Peer lending industry in Britain. All Peer-to-Peer lending platforms must seek and obtain FCA authorisation before they commence lending, and this authorisation must remain valid at all times.
Financial Services Compensation Scheme (FSCS)
The UK’s statutory compensation scheme for savers who hold funds with FCA-authorised banks and building societies. The FSCS compensates savers to the extent that their bank or building society is unable to repay the saver, up to a maximum limit of £75,000 per person per institution. Peer-to-Peer lending is not currently covered by the Financial Services Compensation Scheme.
The amount of interest received before repayment defaults, platform fees and income tax has been deducted. Net interest is the amount of interest received after repayment defaults, platform fees and income tax (where applicable) has been deducted.
The combined value of all outstanding loans expected to be repaid to a given Peer-to-Peer lending platform at a given time.
Loan Part / Loan Fraction
When a borrower requests a loan, certain platforms split the loan up into parts or ‘fractions’ which are then separately funded by large numbers of individual borrowers. Where loan fractions are used, the process can help individual lenders spread risk by allowing them to lend small amounts to a large number of borrowers. Some Peer-to-Peer lending platforms split individual loans into fractions of as little as £10.
The original amount of money borrowed, excluding any interest (regardless of whether that interest has been paid or merely incurred).
Loan Principle Outstanding
The value of the loan principal which is currently still yet to be repaid by the borrower. As the loan is repaid, the loan principal outstanding will fall. Some loans are structured so that the principal is repaid in equal instalments over the course of the loan’s life; other loans are structured as ‘bullet’ loans, where the loan principal is not repaid until the end of the loan’s life.
The length (in time) of a Peer-to-Peer loan. Loan terms range from 30 days through to 5+ years.
The amount of interest received after repayment defaults, platform fees and income tax (where applicable) has been deducted. Gross interest is the amount of interest received before repayment defaults, platform fees and income tax have been deducted.
The fees charged by the Peer-to-Peer lending platform in relation to a given transaction. Platform fee structures vary from one platform to another; some charge an origination fee, others take a slice of the ongoing interest repayments, many take both and some take none from the lender at all. As well as loan-specific fees, there may also be one-off setup fees for both borrower and lender.
Some Peer-to-Peer lending platforms operate internal reserve funds which are designed to protect the lenders against losses in the event that a borrower defaults on their repayment obligations. Reserve fund sizes and their terms vary between platforms. Reserve funds are not compulsory and there are no guarantees over their effectiveness.
Some Peer-to-Peer lending platforms offer an internal secondary market to allow individual lenders to buy and sell ‘loan parts’ (also known as ‘loan fractions’) from or to other individual lenders. Secondary markets are designed to allow lenders to sell-out on their loans before the loan term has finished, allowing them to withdraw funds sooner than they would otherwise be able to. However, a successful sell-out requires both a willing buyer and willing seller and there are no guarantees that a buyer will be found. Where a buyer is found the selling lender may need to take a discount on the value of the loan at the point at which they wish to sell-out. Platform fees may also be applied on any loan fractions traded, on the part of the buyer, the seller, or both.
Some platforms charge a fee to a lender when he or she sells loan parts through an internal secondary market. This fee is generally referred to as a ‘sell-out’ fee, and is typically applied to the total amount of the loan to be sold. Fees vary between platforms.