More on Why Borrower Grades Are Unreliable

• More evidence that the top-grade loans at different P2P lending companies can be of very different quality.
• My thoughts on why you have to demand much higher interest rates from Bondora compared to Funding Circle.

My colleague, Neil, recently gave an example showing that a Funding Circle C grade loan is not the same risk as a rebuildingsociety C grade loan.

You can read about that in Same Loan Grade, Different Risk.

I'm continuing this theme today by looking at Funding Circle vs Bondora.

Funding Circle is a business peer-to-peer lending company focusing on UK businesses.

Bondora is a European wide peer-to-peer lending company with borrowers mostly in smaller European countries.

Recently, Bondora standardised its borrower grades across all countries. That's not to say it assumes the countries are the same; it takes local differences into account, but based on the information it can get reliably it can give the same grades to individuals in similar situations.

Importantly, Bondora does personal loans, not business loans like Funding Circle. So we're not comparing apples with apples. But it's interesting to know about how comparable the grading systems are across P2P lending companies and different types of borrower.

How Funding Circle's and Bondora's best borrowers compare

Funding Circle calls its best borrowers “A+” and “very low risk”. Out of 1,100 A+ loans, not even a dozen have gone bad. That's the total in over four years.

Bondora calls its best borrowers “AA” and “prime”. It doesn't say how many borrowers have gone bad, but it says how many are two months or more late, so I'll use those figures as the bad ones. Based on those, five out of 268 AA loans have gone bad.

This means that Bondora's top-rated companies appear to be roughly twice as likely to fail as Funding Circle's.

This could be an anomaly. Since Bondora has only completed a few hundred AA loans, it won't be as statistically significant. But, as lenders, we have to look at the record more cautiously in that case.

We should certainly, for the time being, keep assuming that the record of Bondora's top borrowers will be considerably worse than those of Funding Circle.

Bondora doesn't check all borrowers' income

One cause of the difference in quality could be the countries that Bondora operates in. Bondora has a few problems that prevent it from checking borrowers' incomes properly.

In the countries its borrowers are, verifying the income of its borrowers doesn't seem to produce better results!

In addition, it doesn't want to do universal checks, because then the applicants can go to other loan providers. Those other loan providers can under-cut Bondora, knowing that the P2P company has done solid checks. I'm not too sure what to make of that as an argument not to check out your borrowers' incomes!

However, Bondora added: “Bondora verifies income for borrowers more frequently than other peer-lenders or credit card issuers.”

Why you should get higher rates from Bondora

With fewer income checks, I currently expect that Bondora‘s borrowers will continue to be of lower quality than Funding Circle. However, this isn't necessarily a problem for lenders, provided you:

• Get much higher interest rates to compensate.
• You can tolerate greater risks.
• You can tolerate more volatile returns by lending for much longer if necessary (till you have recovered any losses in an economic downturn).

The good news is that Bondora and lenders seem to recognise the higher risks, which is why interest rates are around 20%-30%, or double to triple Funding Circle's rates. It seems fair to me.

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