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.
Evaluating a consumer Loan Page 1

 There are exceptions like housing loan wherein house may generate rental income. 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 o

India China

6% 15 %, 24% 52%

o Thailand o Taiwan

Indian population below 35 yrs of Age – 70 % Reach of Formal Banking Channels – 20-25% of Indian population

Evaluating a consumer Loan

Page 2

Source: Cygnus Industry Insight 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. That is why they are priced so high with risk premium built into them. This means that consumer loans are exposed to interest rate risk if the bank funding cost rises high enough.  Cyclically sensitive Evaluating a consumer Loan Page 3 . 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.

Employment and residential stability Evaluating a consumer Loan Page 4 . A bank is granted the right of offset against the consumer’s deposit as additional protection against the risk of consumer’s lending. If the borrower does not have any credit record or poor credit record a cosigner may be requested to support repayment. Is the stated purpose of loan consistent with bank’s written loan policy. Income Levels Size and stability of income is taken into consideration while evaluating a consumer loan application. • Interest Inelastic Consumers are more concerned about the size of monthly payments required by a loan agreement than the interest rate charged.Consumer loans rise in the period of economic expansion and during downturn the consumers become pessimistic and as such reduce their borrowings. A credit bureau report (CIBIL) is used to check consumer’s credit history. 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. 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.

Frequent change of address is a strong negative factor in deciding whether to grant a bank loan.The duration of employment and length of residence also plays an important role to find the stability in personal situation. These are indicators of Money Management skills. Pyramiding of Debt When the individual draws credit at one lending institution to a pay another it is called pyramiding of debt. Framework for Loan Evaluation Evaluating a consumer Loan Page 5 . 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. 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.

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 . 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. conditions. capital. collateral. A person who is considered a good credit risk usually meets six basic qualifications. capacity. and control. CHARACTER (Credit Reputation)…A person with a good character is one who willingly and responsibly lives up to agreements. If yes then the assessment will move on to six C’s of Credit. 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. These qualifications include character (credit reputation).After Hairy ball test the lender will determine if your deal has half a chance.

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.  Credit rating.  Presence of cosigners.. 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. Purpose of loan. CASH…. The factors considered are:  Identity of customer and guarantors  Copies of Social security number. CAPACITY…The ability to repay a loan or make payments on merchandise with present income is known as capacity. If a debt is not paid as agreed. legal structure. the collateral is Evaluating a consumer Loan Page 7 .It is basically cash in hand or liquid securities or funds available with consumer. nature of operations etc. driving license.

bankers will ask "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.. For example. stability of employment. Your collateral represents an "escape hatch" for your bank. The actors which will be considered here are:  Customer’s current position in industry and expected market share. personal factors.  Competitive climate for product  Impact of inflation  Long run industry or Job outlook CONTROL…. Here the various factors which are accounted for are:  Applicable banking laws Evaluating a consumer Loan Page 8 . 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. but banks put more premium on the potential profitability of your business proposal.repossessed and sold to pay the debt. Your collateral is important.last but not the least is what control you can exert on loan application. 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. and other factors that might affect a person’s ability or desire to meet financial obligations are important conditions to be considered.

offered to borrowers are based on the probability of repayment. Lenders use credit scores to determine who qualifies for a loan. at what interest rate. A credit score is primarily based on credit report information. the better a person's credit score. Lenders. Lenders use credit scoring in risk-based pricing in which the terms of a loan. The use of credit or identity scoring prior to authorizing access or granting credit is an implementation of a trusted system.you name it – is actually a series of smaller models referred to as scorecards. like those who have very young credit histories or have filed bankruptcy. use credit scores to evaluate the potential risk posed by lending money to consumers and to mitigate losses due to bad debt. the better the rate offered to the individual by the financial institution. is the most widely used credit scoring system in the financial industry. 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. typically sourced from credit bureaus. FICO®. such as banks and credit card companies. known as a FICO score. What is Credit scoring? A credit score is a numerical expression based on a statistical analysis of a person's credit files. including the interest rate. In general. Evaluating a consumer Loan Page 9 . to represent the creditworthiness of that person. and what credit limits. 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. Every credit scoring model. Fair Isaac Corporation's credit scoring system. Scorecards are models that are designed to best evaluate the credit risk of some sort of homogenous subpopulation. for example. VantageScore® -.

To summarize. Example: Let’s say you have five inquires on your credit report. Don’t make this more complicated than it needs to be.. You add up points and at the end of the game you have a final score. variables and weights. how many inquiries do you have?” Those are all characteristics. In fact. the credit-scoring model decides which scorecard it’s going to use to calculate your score. “Mr. every credit report is broken down into characteristics. That “variable” might equal 25 points (weight). Each variable (answer) to the characteristic (question) is going to have a value or a weight. you end up with your final score. This is no different.more technical. Oh. Credit Report. “Mr. there are many characteristics in every scorecard. Once all of the weights are calculated. Think of a scorecard as a question that the model is asking your credit report.When your credit file is pulled. 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. The weight is simply the number of points you earn for that particular question. how many late payments do you have?” Another example could be.No. and before it is scored. Sample Credit scoring System S.. For example. 1 Factors Customer's occupation and line of work Professional or business executive Skilled worker Clerical worker Student Unskilled worker Point value 10 8 7 5 4 Page 10 Evaluating a consumer Loan . What’s a characteristic? A characteristic is a component of every scorecard. Credit Report. the model is tallying the number of points you’ve earned for various credit characteristics. but instead of tallying runs and pins. Think of a bowling scorecard or a baseball scorecard. there I go. 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.

So. if we decide 28 points as Evaluating a consumer Loan Page 11 . Suppose losses average $600 per credit account and total loss is $72.000.from good loans we get $18. 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.Part time employee 2 Housing status Owns home Rents home or apartment Lives with friend or relative 3 Credit rating Excellent Average No record Poor 4 Length of time in current job More than one year One year or less Length of time at current address More than one year One year or less Telephone in home or apartment Yes No 7 Number of dependents reported by the customer None One Two Three More than three Bank accounts held Both checking and savings Savings account only Checking account only None 2 6 4 2 10 5 2 0 5 2 2 1 2 0 3 3 4 4 2 4 3 2 0 5 6 8 The highest score customer can have in this credit scoring system is 43 points and lowest is 9 points. There were 10% customers scoring 28 points or less who turned as good.000 .

Points can also decide amount of credit to be extended. Point score value or range Credit Decision Reject 28 Points or less 29-30 31-33 34-36 37-38 39-40 41-43 application Extend Credit upto $500 Extend Credit upto $1000 Extend Credit upto $2500 Extend Credit upto $3500 Extend Credit upto $5000 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. For example. Evaluating a consumer Loan Page 12 .000.the cutoff point bank can save loss of $54.

CASE ANALYSIS Evaluating a consumer Loan Page 13 .

per month  Assets – Mutual funds. Analysis: Using Hairy Ball test the application looks not so bad even. 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 .Driving Licence.24000/. 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 . Insurance policy (Cash value – 30000/-)  Expenses – Barely able to meet the expenses from current salary (need more information…) Evaluating a consumer Loan Page 14 .The case has been attached at the end.

Control –  Documentation should. need bills for residential address confirmation)  Mutual funds  Insurance policy – cash value – 30.000  Is the earlier address permanent address? If not. Has 7500/. be available as the applicant is already a customer of the bank Evaluation Evaluating a consumer Loan Page 15 . 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.  Personal guarantee of Aunt (she herself has average credit history)  No fixed landline number? Is the mobile phone connection post paid? (if yes.in hand Collateral – Need more information on parental house and about parents and phone connection. is there a permanent address? Conditions –  Economic slowdown. it seems.

Step 2: Evaluation Using Credit scoring Model and cash flows Following is the credit scoring model prepared for Mr. Two additional factors have been added which are guarantor’s credit history and relationship with guarantor. S. Still.No. 1 Factors Customer's occupation and line of work Professional or business executive Skilled worker Clerical worker Student Unskilled worker Part time employee Housing status Owns home Rents home or apartment Lives with friend or relative 3 Credit rating Excellent Average No record Poor 4 Length of time in current job More than one year One year or less Length of time at current address More than one year One year or less 10 5 2 0 5 6 4 2 4 Point value 10 8 7 5 4 2 Rajan Soni example 7 2 5 2 5 5 2 1 2 Evaluating a consumer Loan Page 16 . 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. Rajan soni.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.

In this case rating of Mr. soni comes to 34 points which is below 36.6 Telephone in home or apartment Yes No Number of dependents reported by the customer None One Two Three More than three Bank accounts held Both checking and savings Savings account only Checking account only None 9 Gurantor's credit history Excellent Average No record Poor 10 Relation with the guarantor Immediate family Yes No 2 0 0 7 3 3 4 4 2 3 8 4 3 2 0 10 5 2 0 3 5 2 0 Total 0 34 Maximum score for this model comes to 54 points Minimum score is 9 points.e 36 in this case turns to be good. Analyzing Cash flows Of Mr Soni: Evaluating a consumer Loan Page 17 . we decide cut off as 36 points. Assumption: on the basis of example given in the literature we have assumed that consumers scoring rating 60% or above of maximum i. So.

100 935 6.930 After degree Gets an additional 10% jump post completion of course 43.600 2768 2500 1000 1.480 14.331 1.946 2.923 Post 3 years Inflow Net take home Total Outflow Lease EMI Insurance SIP Mutual Fund Mobile expense Electricity Expense Food & Clothing Entertainme nt Petrol & maintainanc e Total 6000 2768 2500 1000 1000 850 6000 2000 3000 2511 8 4.131 6.3 00 39.473 29.300 2.000 per month.26 0 2768 2500 1000 1.20 5 3.986 2768 2500 1000 1.00 0 36.923 43.30 8 27.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 27.3 00 36.547 7. We are assuming 10% increase in salary every year on the basis of appraisals 3 year situation Cash Flows During studying in the course 1st 2nd 3rd Year Year Year 30.100 3.930 39.02 9 6.0 00 33.88 6.40 7.21 0 1.00 0 33.8 94 8.0 00 30.473 Page 18 Evaluating a consumer Loan .61 5 2.150 26.450 7986 2768 2500 1000 1331 1131 6946 2315 3473 29450 Net 10.315 3.45 3 6.

2 6 * Assuming 10% increase in salary and expenses each year Evaluating a consumer Loan Page 19 .

The calculations for the following are as follows: Consumer Durable Loan Remarks Consumer durables loan generally have 0% interest but have fee income (eg.200 7500 25% Assumption 2% of loan amount Hence the consumer durable loan should be rejected on the present terms Education Loan As per the prevalent rates in the market today.000 14% per annum 36 12330 28% Page 20 .on a monthly basis 90.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. Processing charges) If loan is approved Amt Interest rate Tenor months Processing fee Disbursal EMI EMI as a %age of take home The current situation of customer does not appear to be the one where he can afford 7500/.000 0% 12 1800 88. 14% is competitive rate in the market If loan is approved Amt Interest rate Tenor (months) EMI EMI as a %age of take home Evaluating a consumer Loan 360.

e. obligation to Net take home is very less Hence can be approved on these terms Education Loan 13% If loan is approved as per the folowing details Amt Evaluating a consumer Loan 36000 Page 21 . Processing charges) If loan is approved Amt Interest rate Tenor months Processing fee Disbursal EMI Remarks 90000 0% 24 1800 88200 3750 Assumption 2% of loan amount Only 982 additional burden on the customer (assuming that we will consolidate the loan with 2768 EMI) EMI as a %age of take home These terms are more acceptable as only 982/. The terms and conditions and the calculations accordingly area s follows: Consumer Durable Loan Consumer durables loan generally have 0% interest but have fee income (eg.is the extra burden. around 15. also it is based on the assumption that the salary would increase by 46% from the base year i.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 EMI as a %age of take home is on the higher side.

and not 43923/- Evaluating a consumer Loan Page 22 .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 25% If after 3 years the salary is revision is 10% instead of 20%) The EMI is more acceptable and the obligation to salary is lower Thus the loan can be accepted on these changed parameters 39930/.