What is on-lending and how does it work?

Beyond the technology to scale, lenders also need funds for lending. Some might even say it’s the most important puzzle of lending. However, accessing funds to finance loans can be a challenge.

Lenders need more funds to grow and reach more borrowers. For example, a startup lender with 10 million Naira in savings can only give loans to about 100 customers at 100,000 Naira each. For a Nation with a 74 trillion credit gap and a high need for credit, that is pretty limited.

While there are several ways to finance a lending business, on-lending remains one of the most underutilized methods, likely due to a lack of information.

On-lending is a financial practice in which a lender borrows funds from a larger financial entity, such as a government, international organization, or bank, and then re-lends those funds to end borrowers.

Some larger entities, like banks, often avoid consumer credit because of its risks. In Nigeria, where the informal sector accounts for about 60% of the economy, on-lending can help more people access loans.

But how exactly does on-lending work, and what are its benefits and challenges? Let’s dive in.

How does on-lending work?

Imagine a local lender deeply embedded in their community and understanding its unique needs. This lender borrows substantial money from a more significant financial entity, such as the World Bank or a government agency. 

The terms of this loan include an interest rate and a repayment schedule, setting the stage for what happens next.

With these funds, the local lender can now provide loans to individuals and small businesses in the community. These end borrowers might be farmers needing capital for their next crop, small businesses looking to expand, or new ventures needing a financial kickstart. 

The beauty of this setup is that the lender sets the terms for these loans—interest rates, repayment schedules, and other conditions—tailored to the specific needs of their clients.

Here’s where the magic happens: The interest rate the lender charges the end borrowers is typically higher than the rate they pay the original lender. This difference, known as the spread, covers the lender’s operational costs and risks and provides a margin for profit.

But it’s not all easy breezy. The lender must ensure that the end borrowers repay their loans on time and in full. That’s where effective risk management comes in. Because regardless of any hiccups along the way,  the lender is responsible for repaying the original loan.

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The benefits of on-lending

So, what are the benefits of on-lending?

Access to capital

Onlending opens the door to capital for sectors and groups that traditional banks might overlook. Think of small businesses, startups, and agricultural ventures—the engines of local economies that often struggle to secure financing.

Local expertise

Local lenders bring a wealth of knowledge about their communities. They understand their borrowers’ unique needs and challenges, allowing them to make informed lending decisions that larger, more distant institutions might miss.

Economic development

On-lending can spur economic growth and development by providing financing to those who need it most. Small businesses can expand, new ventures can take off, and communities can thrive.

Featured read: How the Government can boost the economy via credit ecosystem

The challenges of on-lending

However, onlending isn’t without its challenges.

Risk management

The lender bears the risk if end borrowers default on their loans. This can impact the lender’s ability to repay the original loan, making effective risk management essential.

Interest rate spread

Finding the right balance between the borrowing and lending rates is crucial. The spread must cover costs and risks, but if it’s too high, it can make loans unaffordable for end borrowers, defeating the purpose of improving access to credit.

Market volatility

Economic fluctuations and market volatility can impact the lender’s and the end borrowers’ ability to service their loans. For instance, an economic downturn can increase default rates among borrowers, while rising interest rates can make borrowing from the original lender more expensive. 

How can on-lending transform your loan business?

Lenders, especially small and medium-sized ones, often worry about funding and the stunted growth their businesses endure. While many financial institutions work to bridge the intimidatingly large credit gap, lacking resources frustrates their efforts and even drives some lenders out of business.

On-lending provides lenders the security and resources to scale their businesses significantly without depleting their funds. Lenders can dramatically increase their lending capacity by borrowing from larger financial entities and re-lending those funds to end borrowers.

Imagine growing your lending business from issuing N10 million loans to N100 million or even more. The ripple effect of such an increase can be profound, allowing more businesses and individuals to access the capital they need to thrive.

Examples of on-lenders in Nigeria

Some on-lenders in Nigeria include: 

Bank of Industry (BOI)

The Bank of Industry Limited (BOI) is Nigeria’s oldest, largest and most successful development financing institution (DFI). The Bank of Industry (BOI) helps Nigerian businesses get the funding they need to grow. They partner with commercial banks and microfinance institutions, providing them with resources to lend to businesses under favorable terms. This ensures that entrepreneurs and small businesses can access the capital they need.

Central Bank of Nigeria (CBN) Anchor Borrowers’ Program

The CBN’s Anchor Borrowers’ Program connects small farmers with large-scale processors. It provides loans through financial institutions to help farmers boost productivity and supply raw materials to processors. This program supports agricultural growth and ensures food security by getting funds to those who need them most.

Development Bank of Nigeria (DBN)

The Development Bank of Nigeria (DBN) was conceived by the Federal Government of Nigeria (FGN) in collaboration with global development partners to address the major financing challenges facing Micro, Small and Medium Scale Enterprises (MSMEs) in Nigeria. The Development Bank of Nigeria (DBN) focuses on helping small and medium-sized enterprises (SMEs) overcome financing challenges. They provide wholesale loans to financial institutions, which then lend to SMEs. This approach bridges the funding gap and promotes entrepreneurship across the country.

Other on-lenders in Nigeria and Africa

Lendable

Lendable supports the growth of fintechs in emerging and frontier markets. They provide the capital, expertise and insights that businesses need to scale company growth and deliver transformational impacts in local communities. Lendable uses data-driven techniques to assess risk and provide capital, supporting financial inclusion and helping underserved populations access credit.

Lendsqr

Lendsqr is a fintech company making it easier for lenders to manage and scale their lending operations. Their loan management system offers tools for everything from loan origination to repayment, making the lending process smooth and transparent. The Lendsqr on-lending program boosts financial inclusion and drives economic growth by making credit more accessible across various sectors. Although our technology streamlines lending for many businesses, a common hurdle they face is a lack of funding, significantly impacting their operations. To address this challenge, we launched the Lendsqr onlending initiative.

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Contact us at growth@lendsqr.com to learn more about accessing our on-lending initiative.