Why DeFi is the future of low interest rate consumer loans?

For decades, banks have been the most convenient medium for managing money, for both borrowing and depositing. Convenience and customers’ lack of financial sophistication have enabled banks and fintech lenders to take advantage of this to make high net interest margins deposits and loans — without incentivizing the user.

They have always made banking fancier with the evolution of new financial products like personal loans and credit cards. In the recent times credit cards remain the most ubiquitous credit vehicle amongst users while the increase in personal loan originations has been primarily driven by the growth in fintech. The banks and fintech’s have always been in stiff competition with each other in personal loan lending. In order to not lose such a naïve consumer market, they have been leading towards constant partnerships to cater to the rising demands within consumer finance lending.

Bait for Banks

The global average industry lending rates for a personal loan stands at 11.88% otherwise they can range between 6% to 36%. The banking sector is devouring the customers by gaining on high profit margins because the customers are willing to pay such high interest rates as they are left with no other alternatives.

With rising demand for credit from consumers, banks are now linking interest rates to borrowers’ credit behavior and performance. Now, every single financial action of the consumer depends on the credit score and financial history plays an important role in the interest rate that is decided for the loan you wish to borrow. Even if you are millennial with no credit history, loans are easily available instantly to millennial borrowers with the rise in the number of fintech lenders. So, there is easy access to credit for young first-time borrowers.

Banks and fintech lenders have left no stone unturned to tap into new potential borrowers. Let us cite as example as to why personal loans have been hot within banking. Most consumers love to get their hands on a newly launched product no matter how expensive it can be. Even if their current saving financials do not permit them to take on such a transaction.

The recent launch of the iPhone 12 series has made consumers want to own this latest electronic gadget. Surprisingly, at least 78 percent of the consumers would make this purchase via a credit card rather than pay the lumpsum amount upfront. Study says, they would rather choose a payment option that is flexible and that can be spread over a period.

It might be difficult at first glance to understand why someone might need a loan to go shopping. That’s a fair question. It’s not usually a good idea to take on debt in order to purchase designer bags or high-priced products.

But, taking out a personal loan is exactly that — personal.

Let’s face it, the cost of everything is on the rise. It seems like it’s getting harder to pay our bills all the time. Sometimes you need to make a purchase when you don’t have enough cash on hand. A shopping loan may help you spread out the payments to make the expense easier to manage.

How high is your interest rate?

It is very common for us as consumers to turn to Banks and Fintech lenders to borrow such loans. Borrowing from the wrong lender could cost you a lot, so research your options & choose your loan wisely.

The popular vehicles to take out a small ticket loan are:

1. Credit cards / Cash Advances
2. Personal Loans / Unsecured Loans
3. Pay day loans
4. Point of Sale Loans

Let us look at the interest rates against the above financial instruments.

The most common way to borrow money is on credit cards (called a cash advance). Credit card rates are near a record high, at an average of about 17%. The rate on a credit card cash advance is even higher — up to 25%. The problem with these loans is that they are extremely expensive, with many lenders routinely charging interest rates of more than 400%. Borrowers often can’t pay back these high-cost loans right away, so they get sucked into a cycle of borrowing and racking up finance charges.

The average interest rate on an unsecured loan is currently about 11.25%, according to Bankrate, notably less than the APR on a credit card.

Sometimes customers prefer access to quick cash on short-term loans, generally for $500 or less, are relatively easy to get — often through storefront payday lenders or even online — the interest can easily run into the triple digits.

Lately there have been rise in emerging alternative options to traditional financing. PoS financing solutions, such as those offered by Affirm to Walmart customers, allow retailers to offer fixed-term installment loans to consumers to finance their purchases at the physical point of sale or on the digital checkout windows. In addition, buy-now-pay-later (BNPL) options, which often include interest-free periods, are aimed at customers choosing PoS loans over credit cards.

If we want to understand the future trajectories of the banking industry, we have to look at the expectation gaps that are created by established and emerging value models.

DIGITAL DECENTRALIZED LENDING..

The recent hype of DeFi came about as COVID-19 thrashed the world’s financial ecosystem with noticeable value decrement in global fiat currencies that has resulted in a loss of public confidence. People are seeking alternatives to the traditional banking system and are turning to DeFi products like cryptocurrencies and digital assets.

WHY?

Decentralized Finance at its core is agile and efficient, here is how..

1. You do not need a bank account, maintains anonymity to a certain level.
2. As Defi involves automation the process of borrowing is almost instantaneous.
3. No mandatory credit checks are performed when borrowing a loan
4. Users are incentivized with very lower interest rates while borrowing with no foreign exchange rates whatsoever (if it needs to be converted into another currency.)
5. Allows highly flexible repayment terms.

In the recent news, Japan’s financial giant, SBI, is debuting a Bitcoin lending service. There clearly seems to a merit to this lending value chain.

Imagine if a robust decentralized infrastructure is brought into to disrupt the existing banking infrastructure. This will relatively change the face of lending and borrowing with a real-world use case. Customers will be able to leverage the dynamic market while protecting their assets and gain a tangible incentive for such participation. They no longer have to wait for pre-approval and the high interest rates that are behest of the banks.

Additionally, the open finance infrastructure can benefit consumers in numerous ways, let’s see how it can manifest its advantages:

1. Protects users from price volatility of digital currencies
2. Provide tangible incentive to users who borrow a loan
3. Integration and implementation for a real-world use case

We believe that Defi has the capability to transform and disintermediate the existing banking industry. What makes decentralized finance even more interesting is that it still is in a nascent stage and has the potential to grow exponentially with a proven track record. Loans on various Defi platforms have risen more than thirteen-fold since Jan to $13.2 billion, according to DeFi Pulse. With almost two-thirds of the world’s population without bank accounts who are in possession of a smartphone, DeFi has the power to debut open finance to a large segment of consumers.

Stay tuned for more information.

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Disclaimer:

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