How to choose the right lending model

A lending model is a lender’s map. No sane person leaves point A to point B without some type of physical or mental map. A lender’s lending model is determined by their risk profile or appetite and how aggressive a lender wants to be with revenue, growth and scalability. Does a lender crave aggressive expansion, or is a more measured approach their preference? Whichever path tickles their fancy, a lending model acts as a necessary guide.

Let’s take a look at some of the lending models available to lenders:

1. Mass market

This lending model involves lending to everyone and anyone. In Africa, lenders who use this model are said to serve the bottom of the pyramid. Hence the nickname: bottom of the pyramid. In this lending model, there are two tiers: 

• Deep mass market: This involves using channels like USSD to reach the often financially excluded. Lending through USSD means a lender would lend only small amounts with limited KYC options. They would also have to rely on direct debit payment collection methods since card payment methods would be impossible. Some examples of financial institutions that have popularised USSD are Access Bank and Migo (using quick cash). The high-risk nature of this lending channel is an attribute that must be taken into consideration before venturing in. About 40% of first-time customers will likely not repay their loans, which is why the interest rate is high.
• Surface mass market: This involves relying on channels like the web and mobile apps. Lending through web and mobile apps means a lender has decent KYC options that lower the lending risk. Data can also be ethically spooled from borrowers’ devices to make an informed credit decision. Some examples of financial institutions that have popularised web and mobile app lending are Opay and PalmPay.

Feature read: 4 alternative lending channels to reach underserved borrowers

2. Working class

In this instance, your lending model will be slightly different, as you’ll target individuals with some sort of stable job. Here, they must be able to provide tangible proof of their employment with details such as work address, work email, monthly payslip, etc. These individuals are not as many as those in the mass market, but their risk is considerably lower than that of the mass market, with about 20% of first-time customers defaulting on their loans.

3. Small and medium enterprise (SME)

In this lending model, a lender gives out loans to individuals with small businesses. This lending model is known for its low risk due to the possibility of verifying business location and business cash inflow and outflow. However, mobile apps may not be the best channel to reach SME owners; a web app may be the most suitable channel option. Or, best of all, use the manual loan booking feature to book loans for them.
Featured read: Categories of low-risk borrowers Lenders should target.

4. Buy-Now-Pay-Later (BNPL)

In this lending model, the lender partners with third-party companies or individuals with their own website or platform to embed BNPL loan options for products or services these third parties render. For instance, a lender who partners with a property company to embed Rent-Now-Pay-Later loans. The BNPL lending model is known for its high risk and equally high ROI, making it one of the most popular. Some examples of financial institutions that have popularised BNPL loan embedment are Jumia and Spleet Africa.

Feature read: How to use Lendsqr APIs to power your loan app.

5. Distributor financing

In this lending model, a lender finances a distributor’s raw material or machinery purchase in hopes of being paid on an agreed-upon timeline and terms. Say a distributor intends to buy goods from a large manufacturer like Dangote Cement but doesn’t have the money; a bank or lender steps in to provide a loan to the distributor to fund the purchase of cement directly from Dangote. Dangote then releases the cement to the distributor, who pays back the loan with interest after selling the goods. This lending model is known for its high risk, which is ridden with defaulting distributors. However, it’s a lucrative model. In this model, a lender can use the third-party disbursement feature to disburse loans directly to manufacturers to prevent cases of misuse and to create a trackable financial trail.

Choose a model that fits like a glove

Choosing the right lending model can make all the difference between success and stagnation. As you navigate the myriad options available, remember there’s no one-size-fits-all solution. 
Instead, consider factors such as your target market, risk appetite, and scalability aspirations. And as always, we’ll be here to provide the necessary support. Reach out to us at [email protected].