The Provision Fund
The Provision Fund shields Savers from bad debt
Thanks for the positive response and contributions to our new blog.
One question that we are asked a lot is about the Provision Fund (PF): what it is, why it’s there, and how we manage it. This will be a first post to hopefully answer some of those questions, but no doubt we will revisit the topic.
The Provision Fund is what makes RateSetter different from any other P2P lender. It is a pot of money that shields Savers from defaults from Borrowers. If a Borrower is late on a payment or defaults altogether, the PF steps in to compensate whoever lent the money. If/when that money is recovered, it returns to the PF.
The easiest way to understand the PF is as a company. Credit Rates are like revenues, and any late payments or defaults are like costs. RateSetter acts as the management for the PF, managing both revenues and costs. It’s important to note we have no direct financial interest in the performance of the Fund (though naturally we have a substantial indirect interest).
The reason that the PF exists is because we believe that this is a better way of mitigating the risk for Savers – it drastically reduces the element of “luck” that loans will go bad, that Saver returns will be less than expected. We have a very stringent credit policy, which at the moment declines over 85% of the applications made to it. So it’s important to recognise that the PF makes us no less cautious than if we were lending our own money (which incidentally some of us are).
As it grows, RateSetter gets stronger. As the PF swells, the quantity of loans that we can sustain increases. We are already processing substantially more loans into the market than we did three months ago. This means that there is more to be matched, and more opportunity for Savers to lend money. This virtuous cycle will provide more and more stability as we grow.
It’s important to note however that it is not an insurance product – there can be no guarantee that every Saver will get every penny of interest and capital. The PF is a shield – wielded with the guiding principle of protecting what Savers are owed. We believe it mitigates risk down to a very acceptable level for Savers, but in the unlikely event that its capitalisation was at risk, RateSetter would manage the Fund in an equitable manner to return as much capital as possible to Savers.
“How?” we hear you cry. What Savers really want to understand is how the PF is managed, and in the spirit of transparency that it is at our core, you can now see the Principles behind the Provision Fund on the RateSetter website, to explain how the Fund is and will be managed going forward. It’s not quite the Declaration of Independence, but will hopefully clarify for Savers what they can expect from the Provision Fund.
As always we welcome your comments – we’ll strap on our tin hats – and we will look to post in the future answering them to a wider audience.
Thanks again for lending through RateSetter.
Thanks for this very clear and helpful explanation. The provision fund is an excellent usp, which marks RateSetter out from its competitors. As a new lender, just dipping my toe in for now, although I recognise that the fund isn’t an insurance product, it certainly provides a good level of assurance. One question: there’s a lot of money in the Provision Fund and on the basis that only a small proportion is likely to be drawn on at any one time, is the bulk of the fund invested in the money market, or in bonds or in some other way?
The new information you have posted on the operation of the provision fund is very helpful, thanks. I’m sure like most lenders, my main concern (and why I would limit the amount I have on loan) is the possible failure of the fund should the default rate turn out to be higher than expected. This raises a couple of questions. Firstly, 20% of the ‘surplus’ is due to be returned to savers annually – but what do you regard as surplus? Anything over 1x projected default rate? I would much rather a conservative policy here (especially in the first 3 years, when default rate is largely unknown). A statement as to what level the fund aims to maintain long-term would be helpful, e.g. 2x projected default rate. Also the fund was initially seeded with £150K – is this ring-fenced in any way, or would it be paid to savers as surplus?
How is the Provision fund funded?
Thanks for these questions – we’ve had lots of questions via email as well and we’ll blog again on the Fund soon.
Best
Alex
I think you’re missing a major feature of the provision fund. It removes the need for the individual investor to spread their own risk which significantly speeds operation.
If I want a 3% return on a market sector with 1% bad debit then I need to lend to 100 people at 4%. One will default and I’ll get a 3% return. Of course if I only lend to 100 then I could get 2 or 0 defaulters, so I should really lend to more than 100. Even at 100 this is a big problem. It will take a long while for a 100 borrowers to come along meanwhile my money sits idle. I speak from experience as naturally I spread my risk amongst over p2p lenders.
But with the provision fund the bad risk element is covered for me and I can invest a lump sum that will rapidly be lent out, perhaps to a single investor, and be earning. This works far better for the lender. The risk is spread over far more loans than an individual lender could mange.
A minor suggestion:
It would be useful if the ‘Provision Fund Data’ link actually linked directly to the data in question. I’m all for putting things in context but it somehow feels evasive that it does not.
We have posted a brief update on the Provision Fund on our noticeboard.
The most important point is that the Provision Fund has achieved its aim, and every Lender has received every penny of capital and interest:
http://www.ratesetter.com/noticeboard-item/RateSetterProvisionFundOctober2011.htm
Thanks for the comments as always.