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What Does Retail Banking Mean?
Retail banking is a banking service that is geared primarily toward individual consumers. Retail
banking is usually made available by commercial banks, as well as smaller community banks.
Unlike wholesale banking, retail banking focuses strictly on consumer markets. Retail banking
entities provide a wide range of personal banking services, including offering savings and
checking accounts, bill paying services, as well as debit and credit cards. Through retail banking,
consumers may also obtain mortgages and personal loans. Although retail banking is, for the
most part, mass-market driven, many retail banking products may also extend to small and
medium sized businesses. Today much of retail banking is streamlined electronically via
Automated Teller Machines (ATMs), or through virtual retail banking known as online banking.
It is typical mass-market banking in which individual customers use local branches of larger
commercial banks. Services offered include savings and checking accounts, mortgages, personal
loans, debit/credit cards and certificates of deposit (CDs).
Retail banking aims to be the one-stop shop for as many financial services as possible on behalf
of retail clients. Some retail banks have even made a push into investment services such as
wealth management, brokerage accounts, private banking and retirement planning. While some
of these ancillary services are outsourced to third parties (often for regulatory reasons), they
often intertwine with core retail banking accounts like checking and savings to allow for easier
transfers and maintenance.
What are Retail Loans in Retail Banking?
A retail loan is basically providing credit to individuals for non entrepreneurial activities. Some
of the features of retail loans are:
They are used towards consumption
They have to be repaid by borrower out of his/her own resources.
They do not generate income-generating assets.
There are exceptions like housing loan wherein house may generate rental income.
Evaluating a consumer Loan Page 1
Retail lending has taken a prominent role in the lending activities of banks, as the availability of
credit and the number of products offered for retail lending has grown. The amounts loaned
through retail lending are usually smaller than those loaned to businesses. Retail lending may
take the form of installment loans, which must be paid off little by little over the course of years,
or non-installment loans, which are paid off in one lump sum.
Retail banking in INDIA
Retail assets are just 22% of the total banking assets of India
Contribution of retail loans to GDP:
o India 6%
o China 15 %,
o Thailand 24%
o Taiwan 52%
Indian population below 35 yrs of Age – 70 %
Reach of Formal Banking Channels – 20-25% of Indian population
Source: Cygnus Industry Insight
Evaluating a consumer Loan Page 2
Drivers of Retail Growth
CHANGING CONSUMER DEMOGRAPHICS
Growing disposable incomes
Youngest population in the world
Increasing literacy levels
Higher adaptability to technology
Growing consumerism
Fiscal incentives for home loans
Changing mindsets-willingness to borrow/lend
Desire to improve lifestyles
Banks vying for higher market share
Consumer Loans
Characteristics of Consumer Loans
Regarded as profitable credits with sticky interest rates
Consumer Loans are typically priced well above the cost of funding them, but
their contract interest rates usually don’t change with market conditions during
the life of the loan as do interest rates on business loans today. This means that
consumer loans are exposed to interest rate risk if the bank funding cost rises high
enough. That is why they are priced so high with risk premium built into them.
Cyclically sensitive
Consumer loans rise in the period of economic expansion and during downturn
the consumers become pessimistic and as such reduce their borrowings.
Interest Inelastic
Evaluating a consumer Loan Page 3
Consumers are more concerned about the size of monthly payments required by a
loan agreement than the interest rate charged.
Evaluating a Consumer loan
STEP 1: Evaluating a loan using six c’s of credit
When a Consumer’s loan proposal hits a lender’s desk it will receive what we call “Hairy
Eyeball Test”. Essentially a lender will quickly assess:
Character and purpose
The key factor in analyzing any consumer loan application is the character of borrower and his
ability to repay. A credit bureau report (CIBIL) is used to check consumer’s credit history. Is the
stated purpose of loan consistent with bank’s written loan policy. If the borrower does not have
any credit record or poor credit record a cosigner may be requested to support repayment.
Income Levels
Size and stability of income is taken into consideration while evaluating a consumer loan
application. Generally consumers net income or take home pay is preferred which is also verified
with employer.
Deposit balances
The daily average balance maintained by a consumer also gives a fair idea of size and stability of
income. A bank is granted the right of offset against the consumer’s deposit as additional
protection against the risk of consumer’s lending.
Employment and residential stability
The duration of employment and length of residence also plays an important role to find the
stability in personal situation. Frequent change of address is a strong negative factor in deciding
whether to grant a bank loan.
Evaluating a consumer Loan Page 4
Pyramiding of Debt
When the individual draws credit at one lending institution to a pay another it is called
pyramiding of debt. It is frowned upon by most bank loan officers as are high or growing credit
card balances and frequent returned checks drawn against the customer’s deposit account. These
are indicators of Money Management skills.
Ways to Improve one’s chances of getting a Bank Loan
Home ownership
Regular and stable income
Telephone
Strong deposit balances
Loan officers also look for inconsistencies in application form while asking questions
The challenge of consumer lending is that the default rate on consumer loans usually is several
times higher than that for many types of commercial loans.
Framework for Loan Evaluation
Evaluating a consumer Loan Page 5
After Hairy ball test the lender will determine if your deal has half a chance. If yes then the
assessment will move on to six C’s of Credit. A person who is considered a good credit risk
usually meets six basic qualifications. These qualifications include character (credit reputation),
capacity, capital, conditions, collateral, and control.
CHARACTER (Credit Reputation)…A person with a good character is one who willingly and
responsibly lives up to agreements. One distinctive sign of a good character is a responsible
attitude toward paying bills and meeting obligations on time. The first thing that loan officers
look for when reviewing a proposal is evidence of your trustworthiness. Your loan application
can be rejected without even reviewing your proposed business idea if loan officers find any
evidence in your background indicating lack of integrity. The following factors are taken in
account:
Customer’s past payment record
Experience of other lenders with this customer
Evaluating a consumer Loan Page 6
Purpose of loan.
Credit rating.
Presence of cosigners.
CAPACITY…The ability to repay a loan or make payments on merchandise with present income
is known as capacity. Creditors want to make certain that you will have enough money left over
each month after other fixed expenses have been met to pay your credit debts. The factors
considered are:
Identity of customer and guarantors
Copies of Social security number, driving license, legal structure, nature of operations
etc.
CASH…..It is basically cash in hand or liquid securities or funds available with consumer. It is
considered on the basis of following factors:
Take home pay
Adequacy of past and projected cash flow
Turnover of payables
Expense control
Coverage ratios
Management quality
COLLATERAL…Property or possessions that can be mortgaged or used as security for payment
of a debt are known as collateral. If a debt is not paid as agreed, the collateral is repossessed and
sold to pay the debt. Your collateral is important, but banks put more premium on the potential
profitability of your business proposal. Your collateral represents an "escape hatch" for your
bank, and banks normally want it to be large enough to be able to cover their losses (if at all) and
easily convertible to cash. From your projected cash flow and list of assets, bankers will ask
Evaluating a consumer Loan Page 7
"How can you be sure of your ability to repay the loan? What can you offer the bank as an
alternative source of repayment? Here the bank will consider the following factors:
Ownership of assets
Vulnerability of assets to obsolescence
Liquidation value of asset
Guarantees and Warranties issued to others
Probable future financing needs
CONDITIONS…All other existing debts, stability of employment, personal factors, and other
factors that might affect a person’s ability or desire to meet financial obligations are important
conditions to be considered. For example, a person who has moved six times during the past
year might not be considered a good risk because of living conditions that indicate some type of
problem. The actors which will be considered here are:
Customer’s current position in industry and expected market share.
Competitive climate for product
Impact of inflation
Long run industry or Job outlook
CONTROL…..last but not the least is what control you can exert on loan application. Here the
various factors which are accounted for are:
Applicable banking laws
Adequate documentation
Consistency of Loan request
Inputs from Non credit personnel
STEP 2: Evaluation using Credit scoring model
Once the lender has done subjective assessment of the consumer using Hairy ball test and Six C
criteria then we move to evaluation of application using credit scoring model to arrive at final
decision.
Evaluating a consumer Loan Page 8
What is Credit scoring?
A credit score is a numerical expression based on a statistical analysis of a person's credit files,
to represent the creditworthiness of that person. A credit score is primarily based on credit report
information, typically sourced from credit bureaus.
Lenders, such as banks and credit card companies, use credit scores to evaluate the potential risk
posed by lending money to consumers and to mitigate losses due to bad debt. Lenders use credit
scores to determine who qualifies for a loan, at what interest rate, and what credit limits. The use
of credit or identity scoring prior to authorizing access or granting credit is an implementation of
a trusted system.
Fair Isaac Corporation's credit scoring system, known as a FICO score, is the most widely used
credit scoring system in the financial industry. Lenders use credit scoring in risk-based pricing in
which the terms of a loan, including the interest rate, offered to borrowers are based on the
probability of repayment. In general, the better a person's credit score, the better the rate offered
to the individual by the financial institution.
Every credit scoring model, FICO®, VantageScore® -- you name it – is actually a series of
smaller models referred to as scorecards. Scorecards are models that are designed to best
evaluate the credit risk of some sort of homogenous subpopulation, like those who have very
young credit histories or have filed bankruptcy, for example. The purpose for this multi-scorecard
architecture is to yield the most powerful credit-scoring tool regardless of the type of credit report being
scored.
When your credit file is pulled, and before it is scored, the credit-scoring model decides which
scorecard it’s going to use to calculate your score. Don’t make this more complicated than it
needs to be. Think of a bowling scorecard or a baseball scorecard. You add up points and at the
end of the game you have a final score. This is no different, but instead of tallying runs and pins,
the model is tallying the number of points you’ve earned for various credit characteristics. Oh,
there I go...more technical. What’s a characteristic?
Evaluating a consumer Loan Page 9
A characteristic is a component of every scorecard. In fact, there are many characteristics in
every scorecard. Think of a scorecard as a question that the model is asking your credit report.
For example, “Mr. Credit Report, how many late payments do you have?” Another example
could be, “Mr. Credit Report, how many inquiries do you have?” Those are all characteristics,
and they each have an answer. The answer is referred to as a variable because the answer can
vary from consumer to consumer and from credit report to credit report.
Each variable (answer) to the characteristic (question) is going to have a value or a weight. The
weight is simply the number of points you earn for that particular question. Example: Let’s say
you have five inquires on your credit report. That “variable” might equal 25 points (weight). To
summarize, every credit report is broken down into characteristics, variables and weights. Once
all of the weights are calculated, you end up with your final score.
Credit scoring systems usually select between 7 and 12 items from a customer’s credit
application and assign each a point value from 1 to 10.
Sample Credit scoring System
S.No. Factors Point value1 Customer's occupation and line of work Professional or business executive 10 Skilled worker 8 Clerical worker 7 Student 5 Unskilled worker 4 Part time employee 2 2 Housing status Owns home 6 Rents home or apartment 4 Lives with friend or relative 2 3 Credit rating Excellent 10 Average 5
Evaluating a consumer Loan Page 10
No record 2 Poor 0 4 Length of time in current job More than one year 5 One year or less 2 5 Length of time at current address More than one year 2 One year or less 1 6 Telephone in home or apartment Yes 2 No 0 7 Number of dependents reported by the customer None 3 One 3 Two 4 Three 4 More than three 2 8 Bank accounts held Both checking and savings 4 Savings account only 3 Checking account only 2 None 0
The highest score customer can have in this credit scoring system is 43 points and lowest is 9 points.
Suppose from past records analysis bank finds out that customers scoring 28 points or less, 40% of them
become bad loans that had to be written off as a loss. There were 10% customers scoring 28 points or
less who turned as good. Suppose losses average $600 per credit account and total loss is $72,000 .from
good loans we get $18,000. So, if we decide 28 points as the cutoff point bank can save loss of $54,000.
Points can also decide amount of credit to be extended. For example;
Point score value or range Credit Decision
28 Points or less
Reject
application
29-30 Extend Credit upto $500
Evaluating a consumer Loan Page 11
31-33 Extend Credit upto $1000
34-36 Extend Credit upto $2500
37-38 Extend Credit upto $3500
39-40 Extend Credit upto $5000
41-43 Extend Credit upto $8000
STEP 3: Decision
Using both the subjective( Six c’s of lending) and objective (Credit scoring model) finally a
decision is taken whether the consumer should be granted loan or not.
Evaluating a consumer Loan Page 12
CASE ANALYSIS
Evaluating a consumer Loan Page 13
The case has been attached at the end.
Analysis: Using Hairy Ball test the application looks not so bad even. So we will now move on
step by step
Step 1: Evaluation Using six C Model
Character – Need more information on current outstanding 18000/-
No past credit history as such except debt from the employer (which might be
getting deducted from the salary)
Purpose – Furnishing and for higher studies
Customer’s income level should increase post the course
Credit rating – no past credit history though nothing adverse in the credit
investigations
Aunt as the guarantor
Capacity – Ok
Identity - Driving Licence, presently both the applicant and guarantor are
customers of the bank
Both the applicant and guarantor are in their respective occupation from past from
past 3 years
Cash – Need more information in terms of expenses
Salary - 24000/- per month
Assets – Mutual funds, Insurance policy (Cash value – 30000/-)
Expenses – Barely able to meet the expenses from current salary (need more
information…)
Evaluating a consumer Loan Page 14
Has 7500/- in hand
Collateral – Need more information on parental house and about parents and phone
connection.
Personal guarantee of Aunt (she herself has average credit history)
No fixed landline number? Is the mobile phone connection post paid? (if yes,
need bills for residential address confirmation)
Mutual funds
Insurance policy – cash value – 30,000
Is the earlier address permanent address? If not, is there a permanent address?
Conditions –
Economic slowdown, near revision in salary might not be much
Currently only able to meet the expenses
Defaults in consumer loans have risen in the past few years. There have been job
cuts in the last year or so.
Control –
Documentation should, it seems, be available as the applicant is already a
customer of the bank
Evaluation
Evaluating a consumer Loan Page 15
On the first glance the application does not look as to be one which should be rejected out
rightly, though the customer has not supplied any permanent residence and the guarantee is that
of someone whose own credit history is average.
Still, since the customer has been in the current job from more than 1 year and is himself the
customer of the bank, the application can be re looked with other information furnished as
mentioned above.
Step 2: Evaluation Using Credit scoring Model and cash flows
Following is the credit scoring model prepared for Mr. Rajan soni. Two additional factors have been
added which are guarantor’s credit history and relationship with guarantor.
S.No. Factors Point value Rajan Soni example1 Customer's occupation and line of work Professional or business executive 10 Skilled worker 8 Clerical worker 7 7 Student 5 Unskilled worker 4 Part time employee 2 2 Housing status Owns home 6 Rents home or apartment 4 4 Lives with friend or relative 2 3 Credit rating Excellent 10 Average 5 5 No record 2 Poor 0 4 Length of time in current job More than one year 5 5 One year or less 2 5 Length of time at current address More than one year 2 2
Evaluating a consumer Loan Page 16
One year or less 1 6 Telephone in home or apartment Yes 2 No 0 0 7 Number of dependents reported by the customer None 3 3 One 3 Two 4 Three 4 More than three 2 8 Bank accounts held Both checking and savings 4 Savings account only 3 3 Checking account only 2 None 0
9 Gurantor's credit history Excellent 10 Average 5 5 No record 2 Poor 0
10 Relation with the guarantor Immediate family Yes 2 No 0 0 Total 34
Maximum score for this model comes to 54 points
Minimum score is 9 points.
Assumption: on the basis of example given in the literature we have assumed that consumers
scoring rating 60% or above of maximum i.e 36 in this case turns to be good. So, we decide cut
off as 36 points.
In this case rating of Mr. soni comes to 34 points which is below 36.
Evaluating a consumer Loan Page 17
Analyzing Cash flows Of Mr Soni:
Assumptions:
As mentioned in the case that he is barely meeting his living expenses from his salary we are
assuming current expenses to be Rs 27,000 per month.
We are assuming 10% increase in salary every year on the basis of appraisals
3 year situation Post 3
yearsCash Flows
During studying in the course
After degree
Inflow 1st Year
2nd Yea
r
3rd Year
Gets an additional 10% jump post completion of
courseNet take
home30,000
33,000
36,300
39,930 43,923
Total 30,000
33,000
36,300
39,930 43,923
Outflow
Lease 6000
6,600
7,260
7,986 7986
EMI 2768
2768
2768
2768 2768
Insurance 2500
2500
2500
2500 2500
SIP Mutual
Fund
1000
1000
1000
1000 1000
Mobile expense
1000
1,100
1,210
1,331 1331
Electricity Expense
850 935 1,029
1,131 1131
Food & Clothing
6000
6,300
6,615
6,946 6946
Entertainment
2000
2,100
2,205
2,315 2315
Evaluating a consumer Loan Page 18
Petrol & maintaina
nce
3000
3,150
3,308
3,473 3473
Total 25118
26,453
27,894
29,450 29450
Net 4,882
6,547
8,406
10,480 14,473
* Assuming 10% increase in salary and expenses each year
Evaluating a consumer Loan Page 19
STEP 3: Decision
On the basis of above Six c analysis and credit scoring model we are rejecting both the consumer
durable loan and education loan to Mr Soni. The calculations for the following are as follows:
Consumer Durable Loan Remarks
Consumer durables loan generally have 0% interest but have fee income (eg.
Processing charges)
If loan is approved
Amt 90,000
Interest rate 0% Assumption
Tenor months 12
Processing fee 1800 2% of loan
amount
Disbursal 88,200
EMI 7500
EMI as a %age of take home 25%
The current situation of customer does not appear to be the one
where he can afford 7500/- on a monthly basis
Hence the consumer durable loan should be rejected on the
present terms
Education Loan
As per the prevalent rates in the market today, 14% is competitive
rate in the market
If loan is approved
Evaluating a consumer Loan Page 20
Amt 360,000
Interest rate 14% per
annum
Tenor (months) 36
EMI 12330
EMI as a %age of take home 28%
The EMI as a %age of take home is on the higher side; also it is
based on the assumption that the salary would increase by 46%
from the base year i.e. around 15.5% annually
Thus the loan should be rejected on the present terms
ALTERNATIVE: Alternatively we can give both the loans to consumer with certain changes in
Terms and conditions. The terms and conditions and the calculations accordingly area s follows:
Consumer Durable Loan Remarks
Consumer durables loan generally have 0% interest but
have fee income (eg. Processing charges)
If loan is approved
Amt 90000
Interest rate 0% Assumption
Tenor months 24
Processing fee 1800 2% of loan amount
Disbursal 88200
EMI 3750 Only 982 additional burden
on the customer (assuming
Evaluating a consumer Loan Page 21
that we will consolidate the
loan with 2768 EMI)
EMI as a %age of take home 13%
These terms are more acceptable as only 982/- is the
extra burden; obligation to Net take home is very less
Hence can be approved on these terms
Education Loan
If loan is approved as per the folowing details
Amt 36000
0
Interest rate 14% per annum
Tenor (months) 48
EMI 9837
EMI as a %age of take home 22%
EMI as a %age of take home (if last year income
revision is 10% instead of 20%)
25% If after 3 years the salary is
39930/- and not 43923/-
The EMI is more acceptable and the obligation to
salary is lower
Thus the loan can be accepted on these changed
parameters
Evaluating a consumer Loan Page 22