An update on risk management

By Luke OMahony

Managing credit risk is one of the most important things that we do at RateSetter. The key factors that underpin our risk management are:

  • Portfolio management: we diversify lending across individuals and businesses and actively monitor and control the amount of lending to each sector

  • Excellent underwriting: our expert underwriters conduct robust credit and affordability checks on every loan applicant

  • The Provision Fund: acts as a buffer against bad debts and has ensured that to date, no individual RateSetter investor has lost a penny, although this is not a guarantee for the future.

Sitting behind all this is our team of risk and credit specialists who use various data and tools to analyse, assess and price risk. Over the last 18 months, we have focused on further improving our risk management function, allowing us to price risk more accurately.

We’ve concentrated on three things:

  1. Boosting our risk team with experienced industry experts

  2. Updating and improving our lending decision engines and risk models, allowing us to analyse and predict risk more accurately

  3. Formalising governance and increasing transparency

Boosting the risk team

Since the start of 2016, we have added several senior risk analysis and management experts to our team. This includes the Chair of our Risk Committee Jim Gunner, who was previously senior executive for group risk at HSBC, and Michael Hoare, our Head of Risk Analytics and Retail Credit, who joined from PayPal UK where he was chief credit officer.

Jim and Michael bring with them decades of industry knowledge and experience and have helped us to improve and refine our risk processes.

Updating and improving our risk function

Losses on loans written in 2014 and 2015 are higher than we expected them to be. In response to this, we have made some important changes: we stopped lending through certain channels which were underperforming and tightened our lending criteria. We’ve also improved our analytical capabilities, with new hires such as those mentioned above, new credit scorecards and risk models.

The initial result is that the loan book for 2016, our biggest year of lending so far, is performing within our expectations to date, with 43 per cent of lending from that year repaid. The longer-term result will be that we can price risk more accurately. Because expected loss is one of the key drivers behind the Provision Fund Coverage Ratio, this will in turn help us to build the ratio back up to within its target range of 125%-150%.

Formalising governance and increasing transparency

Our Board Risk Committee recently approved revised guidelines and methodology for assessing future expected losses.

The guidelines commit us to updating our expected loss models each quarter (although the underlying numbers change in real time as loans are written and repaid). The quarterly production will be overseen by a new Expected Loss Committee, which comprises the CEO, CFO and Heads of Consumer and Commercial Credit Risk and will come into effect later this month. We will notify investors via this blog when this update is published.

In summary…

We will also align the methodology for the expected loss figures that we publish on our main website and in the member area to ensure consistency and clarity. At the same time we will expand the performance data that we publish on our statistics page. This will provide a clear estimate of the losses we expect over the lifetime of our loan book, detailing the losses that have already materialised and future expected losses for each year of origination.

Taken together, these changes are materially improving not only the accuracy with which we can price for risk, but also how we report it. Naturally, we have a strong incentive to do both of these jobs well! We will continue to strengthen our risk function, and will keep you updated as things progress.