The second part of this book is about the way that banks assess loan portfolios.

We will explain the different moving parts of credit analytics and will relate them to marketplace lending whenever possible. Before we delve into analytics, let's first revisit the journey banking has taken in recent decades and how this has shaped the way they conduct their business.

Banks play critical roles in societies. Among them is organizing the system of payments, giving credit to businesses in the economy, and safeguarding the funds of depositors. The banking system also allocates capital from those with a surplus of funds (depositors) to those with a deficit (borrowers). It does so by transforming small amounts of liquid deposits into large loans that are relatively illiquid. In a nutshell, by matching deposits and loans, banks provide liquidity to the economy. Intermediation traditionally takes place on the balance sheet of banks, but banks also engage in off-balance sheet operations, for example, offering loan commitments, letters of credit, and guarantees for customers' future investments. Banks further create and trade derivative contracts that allow counterparties to rein in their risks. If they carry out intermediation between creditors and borrowers efficiently, this benefits both individuals and the entire economy. Without readily available credit, economies would be by a magnitude smaller than they are today.

This relatively simple concept of banking has undergone a massive transformation in recent years. The largest banks in many countries have merged into financial service con­glomerates that offer various products, including additional functions such as retail banking, asset management, brokerage, insurance, investment banking, and wealth management. Devel­opments on the product side have occurred in parallel with the emergence of new funding sources. Driven by securitization, mostly of residential mortgages, banks have thrown off the shackles of their deposit base for lending. They have bundled assets on their balance sheets and sold them into the market to finance expansion. Off-balance sheet vehicles, such as Structured

Investment Vehicles (SIVs), allow banks to collateralize assets funded by short-term paper, which generates trading profits and enables them to raise capital to plug funding gaps.¹