What is retail lending and how does it work?

Retail lending is simple: you lend your money to those who want to borrow it. They pay you back the initial amount borrowed plus interest. This interest forms the returns you earn.

Essentially, you kind of become your own small-scale lender, only lending to vetted, creditworthy borrowers.  

A retail platform like Plenti’s is an easy way to match borrowers and investors — it’s like an online marketplace, but for money. 

As they just operate online, retail lenders don’t have the same overhead costs as traditional banks and credit unions. This means you earn better returns as an investor, and borrowers get better interest rates.

A retail lending platform does have some similarities to a traditional lender. It checks a borrower’s credit, including credit history, employment status and credit score. The platform also manages all the details with the loan like establishing contracts, organising payments between borrowers and investors, and managing each investor’s portfolio.   

Basically, it does all the hard work for you.

As an investor, this is great news. You get to avoid all the administration of dealing with lending out your money, but you get returns from both principal and interest as borrowers make regular payments. 

Creditworthy borrowers love retail lending because they get to access funds for major purchases, at competitive rates, without the hassle of dealing with traditional banks.

Global growth

Retail lending is one of the fastest-growing areas in financial services worldwide. Right now investors lend billions of dollars worth of loans each year.

Technology is a big reason why retail lending is taking off. Online platforms and marketplaces make it easy to connect borrowers and investors. 

Here are some of the other reasons for the growth:

• 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?

Even though retail lending is designed to connect borrowers and investors, the two individuals never actually connect on a personal basis. Marketplaces like the Plenti lending platform use technology to match the two. 

There are a few different ways retail lenders do this, but most of the time everything comes down to these two models: a “loan selection” model, or a “loss provisioning” model.

Here’s how those two models 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. 

The loss provisioning model is more popular with everyday investors because it’s easier to manage and provides a level of protection on their returns. 

Why would you take a loan with a retail lender?

Customers choosing to borrow with retail lenders are attracted by the faster, simpler application process, the competitive pricing and the excellent customer service. 

Plus, borrowers might enjoy these additional benefits: 

• 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

How do retail lending platforms match borrowers with investors?? 

Responsible retail lenders provide strict credit checks on anyone who applies for a loan. They’re the same types of checks a traditional lender would make, and they look at the same things including credit history, credit score, income, and employment status.

Once approved by the retail lender, the retail lender then tries to match the borrower with the appropriate investor and their funds, if available, and depending on the type of loan the borrower is requesting, interest rate and so on.

That means investors can have confidence in the borrowers they’re lending to. (Remember, some retail lenders like Plenti provide even more protection with a provision fund¹ but remember, there is no guarantee nor warranty as to any protection from any provision fund, and as such you may suffer financial loss as a consequence of a borrower’s late repayment or default). 

All investors and borrowers are anonymous to each other, so the retail lender is really an intermediary. It helps manage communications, takes responsibility for collecting arrears, and issues reports to investors. 

Perhaps most importantly, retail lenders administer all payments, whether in the form of initial credit (to borrowers) or repayments (to investors). That means investors don’t have to waste time or energy chasing up their investment — they can just enjoy the returns.

¹ The Provision Fund is not a guarantee and investor capital is at risk. Refer to the PDS for further details.

Published August 2022.