What are the risks involved with peer-to-peer lending?back to top
While much has been written about the fantastic returns offered to lenders by peer-to-peer lending platforms, it is important to fully understand the risks involved too. One of the biggest risks to any lender is borrowers defaulting on their loans. Even though Lending Works only lends your money to prime, creditworthy borrowers who not only have an excellent credit history but also can demonstrate that they can afford their loan, there does still exist the risk that some borrowers may default on their loans. This could be due to unforeseen circumstances such as a loss of employment or ill health, or it could be due to something more sinister such as a deliberate attempt to defraud.
Arrears and defaultsback to top
If a borrower is late in making a scheduled repayment, the loan status is said to be 'in arrears'. Lending Works, alongside our debt collection partners, will then make contact with the borrower to notify them and try to recover the funds due. If payment cannot be obtained, our debt collection partner will take steps to recover the debt, for example agreeing a payment plan with the customer. In the meantime, lenders will receive the payments they were expecting - just from the Shield rather than from the borrower. Once we recover those payments they'll be transferred back to the Shield rather than to you as the lender. If the borrower misses more than three consecutive payments, and shows no intent or ability to get back up to date with their repayments, their loan will be placed into default status and we may take additional steps to recover the defaulted sums.
The Lending Works Shield will step in at any time should either (or both) of the above eventuate, thus ensuring that our lenders receive what's owed to them - on time.
Our statistics for arrears and defaults are updated daily, and can be viewed here.
Financial Services Compensation Scheme (FSCS)back to top
Lending Works is not covered by the FSCS, which covers savers up to £85,000 even if the bank holding their funds goes bust. As with all forms of lending, your capital is at risk because there's always a chance that someone won't pay you back. That's why we've gone the extra mile to make sure lenders always receive exactly what they expect, when they expect it, by creating the Lending Works Shield.
How we manage riskback to top
Our number-one priority at Lending Works is earning and maintaining the trust and confidence of our customers and, within that, protecting your money. Whether small numbers of borrowers default because of isolated unemployment or illness, or large numbers of borrowers default because of systemic economic issues such as a recession or financial market crash, our lenders are protected by the Lending Works Shield.
The Shield offers threefold protection including a meticulous underwriting process, a reserve fund which covers missed loan repayments, and a unique insurance which protects against borrower defaults.
Meticulous underwriting standards
The first line of defence in our market-leading lender protection is the strict criteria to which our underwriters adhere when assessing loan applications. Our team is comprised of financial services industry experts who ensure that only the most eligible borrowers are approved, utilising the most effective underwriting techniques, including:
- Credit check - We use data obtained from our primary credit reference agency, Equifax, to run hundreds of automated and manual checks on a potential borrower's credit history. We also check applications using data obtained from Experian and Callcredit, the UK's other major credit reference agencies
- Affordability check - We check income, outgoings, current account management and management of debt to ensure the potential borrower can demonstrate an ability to pay back the loan they've applied for
- Identity check – We use sophisticated software in addition to traditional document verification methods to verify the identities of who we're lending your money to. We take this a step further by asking a series of security questions over the phone too
- Cifas check - We check each potential borrower against the national Cifas register (leaders in fraud prevention) to help prevent fraud
The Reserve Fund is held within a ring-fenced Trust. This account is managed by an independent, not-for-profit Trustee, and is kept separate from the day-to-day operations of Lending Works. The Reserve Fund protects against any missed and late payments and ensures lenders receive their expected returns - on time. The Reserve Fund is constantly growing as a risk-weighted portion of the fees payable by each of our borrowers is used to top it up. It is also maintained at a level that is more than sufficient to cover our expected rates of missed payments and/or defaults. We monitor the Reserve Fund balance closely against the balances it's expected to cover, including stress testing for extreme scenarios.
You can read more about the Reserve Fund by clicking here.
Our insurance is the first of its kind in peer-to-peer lending, and is backed by three of the largest UK household-name insurers tasked with safeguarding your money. On top of being regulated by the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA), these A and B-rated UK insurers each have a balance sheet of more than £2bn. This means big, stress-tested insurers are protecting your money, rather than relying on a reserve fund alone. The insurance policies protect against many of the common causes of borrower default such as:
- Fraud and cybercrime - Our fraud prevention systems combine the knowledge of a broad group of industry experts including identity verification specialists, credit reference agency experts and Cifas (leaders in fraud prevention). However, in the unlikely event that our robust and sophisticated systems are penetrated and fraudulent applications are approved, your money is protected by the insurance.
- Loss of employment - Whether small numbers of borrowers default because of isolated unemployment issues, or large numbers of borrowers default because of systemic economic problems - such as a recession or financial market crash - your money is protected.
- Accident, sickness and death - Our lenders are protected from the risk of missed payments and borrower defaults due to unforeseen circumstances such as accidents, sickness and death. While extraordinary situations such as these are quite rare, they do happen. And if they do, your money is protected.
There are circumstances in which the insurance would not cover a loan default, such as where a borrower could not prove loss of employment or ill health, or if the borrower just decided not to repay. However, in these circumstances the Reserve Fund would be used to cover the loss.
We have developed a three-stage diversification strategy which ensures your funds are diversified across our entire loan book.
Stage 1: Front-end diversification
The first stage of diversification is the specific loan contracts your funds are allocated to. We have developed a sophisticated algorithm which allocates your money across multiple borrowers in the fairest way, based on when you placed your lending offer. We call this the 'Fair Algorithm'. Your money will initially be allocated across multiple loans. If you use Auto Lend to re-lend your repayments, these repayments will also be lent to many more borrowers so it won't be long before you've got a large loan portfolio. This stage is known as 'front-end' diversification, which is an important step in managing the risk.
Stage 2: The Lending Works Shield
The second stage of diversification is access to the Lending Works Shield. All of our consumer lenders have access to the Shield to compensate them if any of the repayments due on their loans are late or if a borrower defaults. This effectively means you are diversified across the entire loan book, provided the Shield is always able to cover these payments. What happens if it can't? Read on.
Stage 3: Back-end diversification
We take diversification a step further by including 'back-end' diversification in our risk management approach. In the highly unlikely event of the Reserve Fund failing to cover a missed payment or loan default, and our insurance policies concurrently not being able to cover this loss, the Trustee (in consultation with Lending Works) may declare a 'Pooling Event'. Before declaring a Pooling Event, it may be possible to top up the Reserve Fund using Lending Works' own funds. However, if this isn't possible, the Pooling Event would ensure that any losses are pooled and allocated to lenders on a pro-rata basis. This ensures that no single lender would be exposed to any individual default. Given that our Fair Algorithm selects which borrowers your money is lent to, rather than you picking your individual loans, we believe the Pooling Event to be the fairest way to protect our lenders against an 'unlucky' portfolio. You can read more about diversification within our platform here.
Regulationback to top
Here at Lending Works, we welcome regulation of the peer-to-peer lending industry, and see it as a positive step forward that favours those platforms which stand for honesty and transparency. Most importantly, it helps to make peer-to-peer lending safer for lenders like you.
Financial Conduct Authority (FCA)
The peer-to-peer lending industry in the UK is regulated by the Financial Conduct Authority (FCA), and Lending Works became fully authorised in October 2016. The FCA's regulatory framework has been designed primarily to achieve the following key objectives:
- Provide additional protection for consumers
- Promote effective competition within the P2P lending industry
- Allow the growth of the industry to continue in a controlled way
- Ensure platforms provide clear, fair and not misleading information, and have appropriate procedures for handling client money
- Ensure firms deal appropriately with customers in financial difficulties and complaints
- Ensure platforms maintain a stable financial position and have contingency arrangements in place in the event of a platform failure
The FCA has also included a number of minimum standards to which all P2P platform providers must operate. This includes minimum capital requirements for the company operating the platform, relative to the size of its loan book. This should give consumers more confidence that the platforms through which they lend and borrow today will still be around tomorrow. Firms are also required to make contingency arrangements to ensure that loan books would be managed to maturity in the unlikely event of a platform failure.
All of this means that our customers should have greater confidence in lending through Lending Works.
Peer-to-Peer Finance Association (P2PFA)
Lending Works is a member of the Peer-to-Peer Finance Association (P2PFA), the industry body for peer-to-peer lending platforms. The P2PFA was set up in 2011 to ensure the rapidly growing peer-to-peer sector maintains high standards of conduct, treats customers fairly, and collectively articulates coherent messages to policy makers.
Members of the P2PFA are required to operate within a strict set of Rules and Operating Principles, including minimum operating capital requirements, appropriate credit and affordability assessments, appropriate AML and anti-fraud measures, secure and reliable IT systems and fair complaints handling. Consumers can have confidence that doing business with a P2PFA member means they are dealing with a reputable business operating to high standards of conduct.
At Lending Works we are committed to operating to the highest possible standards of conduct and we’re delighted to be working with the P2PFA and its members to help promote best practice across the sector.
Other regulation and memberships
- Cifas - Lending Works is a member of Cifas (leaders in fraud prevention)
- Consumer Credit Act (CCA) - Lending Works is subject to the requirements of the CCA, ensuring consumers are appropriately protected by the provisions of this legislation
- Data Protection Act - Lending Works is registered under the Data Protection Act (registration number ZA002001). We take information security very seriously and ensure your personal details are held to the highest standards of privacy
- Anti-Money Laundering (AML) agencies - Lending Works is committed to the prevention and detection of financial crime. We have robust processes in place to identify, prevent and report money laundering and other financial crime
What happens if...back to top
Lending Works fails
Lending Works is well funded and has a sustainable business model. However, in order to protect our customers in the very unlikely event that Lending Works ceased to exist we have an agreement with a back-up services provider. The back-up services provider would step in to manage the remaining loan agreements to maturity and ensure that all loan repayments continue to be made to our lenders as planned. You can read more about this by clicking here.
Please note that there is no recourse to the Financial Services Compensation Scheme (FSCS).
The Shield fails
If at any time, in the opinion of the Trustee, the Lending Works Shield does not have sufficient funds to satisfy the claims arising from the loans outstanding (a deficit), and, the deficit is not, in the opinion of the Trustee in its sole and absolute discretion, capable of being rectified through the ordinary course of business, the Trustee in consultation with Lending Works may declare a “Pooling Event”. If a Pooling Event occurs, the value of the outstanding deficit will be split or 'pooled' among all existing lenders on a pro-rata basis. Given that lenders rely on the Fair Algorithm for the allocation of their funds, and do not make the choice themselves, we believe the Pooling Event to be the fairest way. The link in the Diversification section above explains in further detail.
A borrower misses a payment
If a borrower is late in making a repayment, Lending Works will initially attempt to make contact with the person and resolve the matter without involving the Collector or the Trustee. At the same time, the Lending Works Shield will make the payment to the lender to ensure they receive what they're expecting - on time. Lending Works will then take the steps described in the 'Arrears and defaults' section above in order to attempt to recover the outstanding debt from the borrower.
A borrower defaults
In 2014, the P2PFA issued a standard definition for the differentiation between arrears and defaults. You can read more about this here.
Typically, however, we declare a borrower to be in default if they fall more than three months behind their scheduled repayments. That means lenders receive the outstanding capital balance of that particular loan contract in full. The only minor inconvenience to the lender will be that they will then need to re-lend these funds once they are returned to the Wallet, although this can be done automatically using Auto Lend.
Any sums subsequently recovered from the borrower ('recoveries') will be reimbursed to the Lending Works Shield.
A borrower dies
In the event of a borrower passing away, the lender is protected. We handle such cases with a lot of sensitivity and care. Lending Works will contact the borrower's Estate, and seek to recoup the entire capital balance outstanding. Should the funds from the Estate be insufficient to cover the full amount owed to the lender, the difference will either be made up by the Insurance as part of the Shield cover or by the Reserve Fund. Either way, the funds will be transferred into the lender's Wallet immediately on default. The only minor inconvenience to the lender will be that they will then need to re-lend these funds once they are returned to the Wallet, although this can be done automatically using Auto Lend.
A lender dies
Unfortunately these situations can arise, and our customer service team will try to handle this in a sensitive manner which is as straight forward as it can be. If a lender dies, once we've obtained the appropriate evidence such as certified proof of death, we will recover the capital balance owed to the lender on all outstanding loans and close the account. Once the account has been closed, we will transfer the funds to the lender's Estate, which will then handle it from there. We will not charge any fees for the use of Quick Withdraw in this instance.