How do platforms analyse borrower risk and creditworthiness?
Peer-to-peer lending platforms use a process of risk assessment to try to quantify the extent to which any given loan applicant represents a creditworthy, or non-creditworthy borrower.
Many platforms will have minimum benchmark risk thresholds which must be met in order for that individual or business loan applicant to be eligible to apply for a loan with that platform. For example, a business loan platform might require that any prospective borrowing business is registered as an established Limited Company.
They may also require that the company provides access to (amongst other information) 3+ years’ worth of signed financial accounts. For individual applicants, it may be that the platform requires the applicant to complete an affordability assessment, or alternatively they may be asked to provide a guarantor to underwrite the repayment of the loan amount in its entirety.
Personal lending risk profiling
The risk assessment process will typically look at a number of factors to determine whether the individual in question is an appropriate borrower. This would include the nature of the loan they are in the process of applying for, the amount and intended use of the loan, the likely interest rate, the platform’s available capital, and the timing, size and shape of the loan repayment payments.
Typically, this process will begin with reviewing the basic information provided at registration; the applicant’s age, employment status, salary, any outstanding debt elsewhere etc.
This will usually be paired with a formal credit scoring process using one of the UK Credit Reference Agencies (such as Equifax or Experian). The borrower’s credit history will likely be reviewed in depth through a largely automated process and the lender will begin to build a picture of that individual borrower’s creditworthiness in light of their existing debt, existing borrowing facilities (whether drawn or undrawn), financial/borrowing history and other assumptions (for example, the process might look at how many other prospective lenders have reviewed that individual’s credit file in the last 30 days – an indication of what the other lenders thought of the potential borrower).
It may be that at this stage, the platform has determined that it either does, or does not, feel that an individual applicant represents a creditworthy borrower and it may either extend or reject an offer there and then.
In some cases, the peer to peer platform may wish to conduct further credit scoring in order to refine the risk profile that it has built for the prospective borrower. The applicant may be asked to provide access to further information, such as historical and current bank statements, in order to enable the peer to peer lender to understand how well that individual applicant is able to manage his or her money.
Once the additional information has been obtained the lending platform is then in a better situation to determine the creditworthiness of the would-be borrower. An automated algorithm will be used to determine, amongst other things, the borrower’s current outstanding debt, the affordability of the proposed loan, and a gauge of the extent to which the borrower is able to meet the interest/repayment obligations each month, as a proportion of that applicant’s free monthly or weekly income.
Once the platform has determined the extent to which the would-be borrower represents a creditworthy applicant, a risk-pricing model will be used (either manually or automatically) to determine how the loan should be priced in terms of interest. This will be a factor of all of the above considerations, as well as the amount, term and purpose of the loan that the borrower is asking for.
Business lending risk profiling
For business applicants seeking a peer-to-peer loan, the risk analysis process is arguably less straightforward than for individual borrowers, simply because far less of the information pertinent to a lending decision is less immediately available and/or quantifiable.
Many platforms offering business loans under the IFISA tax wrapper are likely to begin their risk analysis process by filtering out those applicants who fail to meet their initial fixed lending criteria. These might refer to the applicants’ trading history, turnover, legal structure, sector, historic and current operational profitability etc. For example, a platform might require that all applicants have an established trading history – perhaps 3 years worth of filed accounts – as well as an established level of turnover (say, a minimum of £200,000 per year for the past 3 years), a limited company legal structure, and/or a freehold asset to be used as security.
Once these initial hurdles have been met, those applicants who are eligible will be likely be reviewed for their creditworthiness individually, with loans priced according to their precise circumstances. For business loan applicants, the shareholders and directors of that business may be subject to individual assessment as part of a businesses’ credit scoring process – particularly if they are to provide personal guarantees over the loan repayments. The applicant business itself will likely be assessed for how well it generates cash, how much cash it needs in order to meet its daily operating requirements, and so on. In all cases, consistency and visibility of income are very important.
The risk analysis process will also seek to assess whether there is some element of the company’s assets that can be secured (i.e. used as collateral against the loan). This might be land and buildings, or equipment, or stock, or even a list of outstanding sales invoices due in from customers. In some cases, a ‘fixed and floating charge’ may be put in place over the entirety of the company’s assets.
Property lending risk profiling
With property-based peer to peer lending, the risk analysis process is likely to be driven to a large extent by the nature of the property itself, and the purpose of the loan.
A borrower wishing to borrow funds via a property peer to peer platform will be assessed partly as an individual and partly as an individual property owner.
In such a situation, the property itself will be reviewed either from a rental yield perspective, or from a redevelopment perspective, or both, depending on the nature of the site and the intended use of the loan. This is in order to determine the likelihood that the property in question will generate enough in rent (or generate enough redevelopment profit) to pay down the peer to peer loan in accordance with the prospective loan agreement.
The property will also be reviewed in terms of how much of the loan amount could be recovered in the event that the borrower were to default and the property were to be sold (bearing in mind that the property may need to be sold at a discount to its true market value in the event of borrower insolvency).
Updated: Monday, February 18th, 2019