The Bankwatch

Tracking the consumer evolution of financial services

Posts Tagged ‘risk management

Thoughts on p2p lending, risks and the future of the industry


In times of business renewal and especially following times of crisis it becomes easy to develop simple homely answers to problems. Mark Gimien falls into two traps, namely, coming up with a simple explanation that summarises a diverse set of peer-to-peer lending players, and that of a few simplistic anecdotes designed to explain a complex situation.

Person-to-person lending is much riskier than you’ve been told | The Big Money – Slate

Her credit rating is not bad. But then you lean back in your chair and wonder, “Wait a second! Why in heaven’s name would someone pay me this kind of money to take a loan to repay her other debts?” You might wonder what the heck the interest rate is on those loans, and how she could possibly be reducing her costs this way. You might even wonder—actually, it would be your job to wonder—if there’s something fishy going on here.

It is hard to know where to begin when a coffee shop answer is provided to answer something that is potentially game changing. The peer-to-peer lending model to date has two definitive characteristics.

  1. evolution: what peer-to-peer lending is now, bears little resemblance to that which first sprouted roots in 2005
  2. governance: peer-to-peer lending now falls within the gamut of securities regulation, with the overviews, sophistication and some might argue dilution of the original model

These two components of the peer-to-peer lending history are important, and worth reflecting on:

Evolution:
The original vision for peer-to-peer lending was formed at a time when internet models were evolving from web sites to social interactions. The notion of wisdom of crowds and the ability of a larger group to prepare better decisions than discrete individuals was prevalent. Prosper to their credit took that vision literally and applied it to peer-to-peer lending. Zopa and later Lending Club took a more traditional personal lending approach when implementing their model. The spectrum of peer-to-peer lending has evolved from those early days over a five year period, to one with clearly defined risk management principles in place, and generally one, based on solid borrowers with good credit.

Next there are the unexplored aspects of peer-to-peer lending and Wiseclerk does a good job [For Debate: Can Data from Social Networks be Used to Reduce Risks in P2P Lending?] at considering some of those aspects.

The core of the evolution however is the shift to refinement of risk categorisation that ought to offer consistent risk and return. It will never mean no losses – lending always involves default rates. The issue lies in the predictability of those rates. It will mean that as scale and volume develop on peer-to-peer lending platforms, risk categories and their associated default rates will trend towards normalization and consistency.

Governance:
The evolution above is occurring and will continue based on self preservation of peer-to-peer lending financial service operators. The thing that will prevent jumpstart operators from appearing and getting outside normal risk decision management is good governance. Banks and brokerages are not left to their own devices in development of governance and when peoples money is at stake, neither should peer-to-peer lending operators.

The securities regimes in US and Canada have taken the lead on regulation and governance of peer-to-peer lending based on the premise of debt offering representing a security. That regulatory approach may shift based on recent developments in the US Congress, but in any event, regulation will be there to ensure peer-to-peer lending operators remain within acceptable parameters that protect investors. That protection is based not on loss avoidance but on appreciation of risk, and both willingness and ability to withstand loss. The degree of loss will be defined by the characteristics outlined in the evolution section prior.

Summary:

Its too easy to raise the matter of the recent economic crisis. The characteristics of evolution and governance mentioned are systemic and will remain through thick and thin. Economic crisis merely increase unemployment, decrease business growth and the result is increases in default rates. That increase is broad based and not related to the matters of risk management and governance. In fact by definition, good governance says that investors understood the risks, and while they dislike increased losses, are able to see beyond that.

Banks have serious issues as recognised by the same Mark here. Personal lending as old as the hills. In fact Banks are relatively new to personal lending, having become involved only on a large scale during the last 40 years. To suggest that a newer model for lending that happens to be called peer-to-peer lending, and that removes many middleman costs, thus improving rates for borrowers and lenders alike notwithstanding being closer and closer to being based on traditional back to basic banking principles, is not a bad thing and a step back to basics. A little simplicity cannot be a bad thing after what we have witnessed in the fallout since 2008.

Written by Colin Henderson

January 20, 2010 at 21:46

The Canadian bank model secret? | risk aversion


The general theme that the ‘Canadian Bank model’ is superior has constantly intrigued me, having been personally involved there.

Size and Diversification: They are smaller and less diversified, so some risk mitigation appears there. This is probably the biggest reason.

Number: There are only five of them, of any consequence, so a couple of regulators can do a lot of supervision there.

Loan restriction: there is a restriction on loan participation relative to capital.

Purdy Crawford/ Pan Canadian Investments: The Canadian government did presciently freeze $35 billion in derivatives back in 2007.

But no … in aggregate there is no enormous winning theme, or singular secret in Canada.  In typical Canadian form its the softly softly approach, and David Olive in todays Star sums it up nicely with this quote below.

They are just plain old fashioned ‘risk averse’ supplemented by being too small (asset size is whats important here, not market cap) to take part in large scale international risky investments.

Obama eyes Canada as bank model | The Star

As a result of their largely shunning the purchase of multimillion-dollar packages of U.S. junk mortgages, Canadian banks have earned international acclaim for their continued sound condition. But that had nothing to do with the Canadian banks’ size or diversity of functions, and everything to do with prudent risk decisions and scrupulous regulatory supervision.

Written by Colin Henderson

May 4, 2009 at 16:00

New thinking for Risk Management | Deloitte


Risk management has come under the microscope of late, and clearly new thinking is required.  Recently Andrew Haldane of the Bank of England reflected to the weeks and months that it took to work “stress test” models within banks and how that is clearly unacceptable.  He described stress testing as being less “regulatory arbitrage” and more “regulatory camouflage”. (my post summarising Haldane)  (Haldane – BofE pdf)

The Deloitte Center for Banking Solutions has a new report out that focusses on providing for an integrated approach across the enterprise.

Integrated Compliance and Risk Management Rethinking the approach

Unprecedented market turmoil in the industry has compelled financial institutions to rethink their existing compliance and risk management programs, many of which have failed to keep pace with evolving levels of risk. As a result, financial institutions are taking a critical look at how they manage compliance and risk to gain a better understanding of how their institution is impacted by the dynamic risk environment of a global financial community.

I think this is a great start.  The thinking will need to then focus on the methodology that will accommodate the other factors that Haldane spoke of, ie, disaster myopia, network externalities, and misaligned incentives.  These are important because current risk models do not adequately address those factors for most organisations.  This gets into the methodology that will have greater chance for success and that will operate at the speed and alacrity that the real-time world requires.

Written by Colin Henderson

February 25, 2009 at 14:40

%d bloggers like this: