Getting a Grip on Risk
Ram Ahluwalia, CEO of PeerIQ, says peer-to-peer lending’s biggest challenge is understanding and managing risk. —T.A.
Q: What’s the biggest challenge in P2P?
A: The current economic environment. There’s a lot of capital chasing P2P loans that offer short duration and high yields in an otherwise low-interest-rate and low-default-rate environment. There’s also no obligation for investors to fund loans; they can change their minds if their perceptions of risk and return change. P2P platforms need to ensure they have access to diverse and sticky sources of funding that won’t suddenly disappear.
Q: What’s next?
A: Consumer and small-business credit is transitioning to the capital markets, with bank regulatory requirements a key driver of this trend. As bank balance sheets shrink, institutional investors and nonbanks are filling the gap. You are going to see dramatic growth in securitization and demand for risk management tools, like the ones we are building. I think you’ll have a very robust asset-backed-security market that underpins the industry growth.
Q: What’s so hard about managing risk?
A: There is no standardized valuation methodology for P2P loans. There is no mark to market. Funds use different valuation approaches. Also, there are asset and liability mismatches. Hedge funds may own pools of P2P loans with three- or five-year duration yet only offer quarterly liquidity. These mismatches are exacerbated in a downturn, when redemptions tend to accelerate. PeerIQ allows clients to benchmark loan performance, manage portfolios, meet reporting requirements, and project cash flows across scenarios.
Q: What about derivatives?
A: Securitization and structured products go hand in hand. The tools we’ve built to help institutions understand their risk can be used to structure and price other financial products, such as insurance-wrapped P2P loans. Risk transfer instruments are something that clients ask about and will eventually be part of a robust risk management tool kit. Institutions and banks are more willing to fund P2P, potentially through a credit cycle, when they know they can manage their risk responsibly.
Article originally published at: https://www.bloomberg.com/news/features/2015-09-03/four-entrepreneurs-talk-about-the-fintech-revolution