Blog | RateSetter

Improving the accuracy of the Provision Fund Coverage Ratio 2

By Luke OMahony

Our aim is to ensure that the Provision Fund Coverage Ratio is as objective and accurate as possible. With this in mind, we are reviewing the methodology that underpins the calculation of the Coverage Ratio. We will implement the outcome on 13 April and our expectation is that the result will be neutral to a slight increase in the Coverage Ratio.

Investors will be familiar with the Provision Fund “Coverage Ratio”, which is updated in real-time on the Provision Fund page. It is a measure of the Provision Fund’s ability to cover expected bad debts, and is calculated by dividing the size of the Provision Fund by the expected level of future losses from active loans.

We arrive at the expected bad debt figure as follows. The expected loss for every active loan is calculated by giving the loan a likelihood of default and then taking into account the fact that we do often recover money after a default occurs. We then aggregate the figures to give a total expected loss figure.

The likelihood of default is anchored in the huge amount of information we receive from credit reference agencies on personal loan performance and is then updated based on our own empirical information as the loans mature. Our likelihood of default data becomes more accurate as the amount of data on the performance of RateSetter-specific loans increases and as the data becomes more mature (because likelihood of default itself is of course dynamic as the loans are repaid).

Overall this means our estimate for expected losses is becoming more accurate. It follows that the Provision Fund Coverage Ratio is becoming more accurate. It is a clear goal of ours to ensure that the Provision Fund Coverage Ratio is as accurate as possible so that we have a very sound basis for displaying the strength of the Provision Fund.

It is important to clarify that our aim is to make the expected loss figure as objective as possible, thus eliminating subjectivity. We could of course build in economic forecasts and assumptions but we believe it makes sense to anchor the figure in empirical data to ensure it is completely clear. We are, of course, very aware of the potential impact that changes in economic conditions can have on the performance of loans and this is the main reason why the Coverage Ratio is higher than 100% – we will return to this subject in due course.

We last reviewed the appliance of the Coverage Ratio methodology in September 2015 and we are now undertaking another review (we are continually looking to improve our business and so reviews are normal). The outcome will be implemented on 13 April and our expectation is that the result will be neutral to a slight increase in the Coverage Ratio.

Going forwards, as the amount and the maturity of our data increases, we plan to undertake more regular reviews of the application of the methodology and we will communicate this to you each time. This, along with the wider range of data we publish, ensures that RateSetter continues to lead the way in providing investors with accurate and transparent information. Transparency, alongside prudence, is a key tenet of RateSetter.

To read further detail about the methodology and the changes to it please log into your account and click on RateSetter Notices.