One of the things that makes our peer-to-peer lending platform unique is our use of reserve funds for credit risk management.
Reserve funds exist to protect investors from future expected credit losses.
In the event that a borrower defaults or misses repayments, the reserve fund ensures the payment back to the investor is still made (provided there are sufficient funds available).
We have a reserve fund for each of our three investment classes: home loans, personal and consumer finance loans, and business property loans.
When you’re investing into a particular class, you’re only exposed to that class. That means that if you’re investing in home loans, you’re not exposed to personal loans or business property loans.
A percentage of the borrower interest is automatically diverted into the reserve fund for that borrower’s investment class.
The amount of interest that we divert may be a lot or a little – it all depends on how risky the borrower is determined to be.
When we determine a borrower’s credit risk, we look at a whole range of factors, including:
All of this information helps us set the amount of borrower interest that is diverted to the reserve funds, to ensure we have enough.
We also assess our ability to recover that money if a borrower does default. The probability of recovery for home loans and business property loans is quite high, especially if the loan is relatively small compared to the value of the property.
However, the probability of recovering money from personal loan and consumer finance products is lower, as loans below $20,000 can be unsecured.
Even with our robust credit risk management and planning, there could be a situation in the future where there’s not enough money set aside in a reserve fund.
In this situation, we would put the reserve fund into active management.
Active management is when our socialisation clause kicks in. It gives us the ability to divert part of the borrower interest that an investor would normally receive into the reserve fund so we can build up additional reserves.
Investors lose interest, but they are better protected against any future credit losses.
We won’t wait for a reserve fund to run out of money before we put it into active management. That’s because we’ll get some clues along the way, allowing us to prepare.
For example, if a reserve fund is running down due to some sort of macro event or an unprecedented spike in credit losses, we will push that investment class into active management.
It’s all about making sure that we’re acting in all of our investors’ best interests. We’ve designed our platform to give you stable and predictable returns, and to reduce your risk as much as we possibly can.
Although we have a hardy system in place for assessing a borrower’s credit risk and protecting our investors, peer-to-peer lending is not 100% risk-free. To dig into the details, here are the possible risks with peer-to-peer investing.
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The opinions expressed in this article should not be taken as financial advice, or a recommendation of any financial product. Squirrel shall not be liable or responsible for any information, omissions, or errors present. Any commentary provided are the personal views of the author and are not necessarily representative of the views and opinions of Squirrel. We recommend seeking professional investment and/or mortgage advice before taking any action.
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