How does Funding Circle assess loans?
At Funding Circle we take credit assessment very seriously and have strong processes in place to assess businesses before they are listed on the marketplace. We recently sat down with Jerome Le Luel, Chief Risk Officer for Funding Circle, to talk about how our processes work.
Q: Hi Jerome. Thank you for agreeing to speak with us. To start with, could you tell us a bit about your role at Funding Circle and your background before joining us?
A: Hi, I’m Jerome Le Luel. I’m the Chief Risk Officer for Funding Circle. In the last seven years I’ve worked with Barclays in the UK, where I was in charge of risk management for Barclaycard and I was also in another job at Barclays, in charge of risk analytics for the entire bank.
Q: Could you give us a brief overview of how we assess loans at Funding Circle?
A: To assess loans at Funding Circle we go through a very thorough process which combines several tools. Firstly, we are applying some straight rules to exclude any business that would not fit our risk appetite.
Secondly, we are using statistical models to predict which of those businesses passing our lending criteria are actually the ones we want to lend to given the profile of the business, the industry, the loan amount they want, the strengths of their financials, the credit history of the business but also its directors.
And finally, we also leverage the expertise of a great team of experienced credit assessors – people who have worked in the industry for many years. They look at every application individually and they overlay their judgement. They have the authority to right-size the loans based on affordability and to exclude loans that might not fit the criteria when we go into this kind of refined assessment.
So it’s very much a 360 picture of every business that we look at, and using different lenses to make sure we’re not missing anything.
Q: Is there someone looking over each application?
A: Each application is looked at by one of our staff members. We believe that we can’t make good credit decisions by just relying on scores and statistics – our trained staff are also involved in reviewing every application, making sure that all the materials are genuine, but also interpreting the financials, the demand of the loan size, and making sure it is commensurate to the business needs. So applying this human judgement is very important to complement the model of scoring that is part of the decision.
Q: In terms of the loan book, how has Funding Circle performed over time?
A: The credit performance of the Funding Circle loan book in the UK has been very stable over time. Over the last four years the performance has been very strong. Typically, credit losses on an annual basis have always been below 2% which is better than the average of the UK market.
Over time, we have actually expanded our risk appetite, we’ve introduced new risk bands, but we’ve done that at a point in time where we knew we could control it. So the average risk of the book has remained less than 2% even though our acceptance rate has gone up.
Q: Moving forward, how do we continue to make improvements to the way we assess businesses?
A: At Funding Circle, we believe that being the best at assessing credit risk is going to be a key competitive advantage to win the interest of our investors. We need to deliver a very stable risk performance, and we need to make sure we are extremely precise in our decisions. So one thing we keep pushing all the time is to refine our models and leveraging data that is available.
When we introduce changes to the risk process we also calibrate those changes using recent performance to make sure that those changes are not going to distort the performance barriers.
Q: How do we help more small businesses access finance, while continuing to protect investors’ interests?
A: We don’t need to loosen our credit appetite to attract more business; it’s more a matter of demonstrating that the service is superior and letting people know that it’s available through proper brand advertising.
Q: Finally, how prepared are we for market downturn? Has our loan book been stress-tested at all to see what would happen in the case of a recession?
A: We need to understand the volatility we can expect. For that, we put the book through analytical stress testing. We simulate what the book would do in a downturn to understand how much credit losses would increase by. What it’s shown is that in an extreme downturn scenario, the credit losses would increase by around 50-60%.
The second thing we do is we make sure that the loans are priced so that in the eventuality of this fluctuation, on average investors would not lose principle in their investment. And if you think about the book we have in the UK, on average we deliver a net yield of around 7% and the loss rate is less than 2%. So if you apply very simple maths of this 2% increasing by 50% it becomes a 3%, and that 7% yield would become a 6%. So that gives us comfort that there is a buffer in the system to navigate through a recession.
The Funding Circle team