What is retail lending and how does it work?
- the recent adoption of comprehensive credit reporting in Australia;
- the introduction of Open Banking in 2020;
- increasingly stringent regulation of credit card debt and a move away from interest accruing credit card balances; and
- the shift in consumer perceptions following the reports of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry.
So, how does retail lending work?
- Loan selection model: In this model, the retail lender packages loans into different risk grades, like low-risk or high-risk (based on the credit worthiness of the borrowers’ applications). Investors choose which category they want to invest in. Naturally, the slightly riskier loans provide a higher return, but typically a higher default rate.
- Loss provisioning model: In this model, the retail lender charges borrowers a fee, based on their risk profile. These fees are pooled together to form a Provision Fund. The Provision Fund can help protect investors from late payments or defaults. This way, investors get to enjoy their returns without worrying about an individual borrower’s credit risk level.
- Better rates: retail lenders offer more competitive rates than traditional lenders
- A personalised rate: instead of just offering a blanket rate for everyone, retail lenders typically reward borrowers with good credit history with a lower rate
- A fast, simple experience; retail lenders typically have an easier, online application process
- Flexible product: no early repayment or exit fees if they decide to pay their loan off early
- Easy loan management: The ability to shift away from expensive forms of credit, like credit cards, to a comparatively manageable loan with a simple payment plan