Interest is both the cost of borrowing money for a borrower and the compensation of lending money for a lender. As a lending platform we’re right in the middle and connect borrowers to lenders. So, we have to attend the needs of two sides of the same coin. We’re tasked with agreeing on attractive terms for both the borrower and the lender. Views on what are attractive terms change, but never as disrupting as over the last couple months. We have responded by reviewing the pricing of our loans more frequently. With this article we give an overview of what has happened and what we’ve done.
What happened
Lately, you cannot watch the news without an article covering inflation or rising interest rates. The ECB has a striking recap of what has been the source of it all:
Since Russia’s invasion of Ukraine we have been facing a situation in which inflation is too high but the economy is slowing. Prices have increased a lot owing to the war, especially for energy and food. Many companies are also finding it more difficult to get the materials, spare parts and workers they need for production, which is worsening problems that were already there because of the pandemic.
In response to high inflation, central banks have increased their interest rates rapidly. By making borrowing more expensive and saving more attractive, central banks aim to reduce demand for goods and services. Next to that they aim to reduce the expected inflation, to stabilise business prices and wages.
How that affects October’s rates
The interest rate that we charge to borrowers, or pricing, is determined by several factors:
- A company’s credit score
- The risk-free return in a company’s country of origin
- The type of analysis applied
- The level of security
- The duration of the loan
The central bank interest rates set the benchmark for the interest rates charged by financial service providers. It also increases the return on a risk-free investment, like some country bonds or saving money with the bank. Lending to SMEs, like you do through October, entails a risk that your investment is not repaid. Interest is the compensation for that risk. Therefore, the interest rate has to increase to keep the same relative compensation for the risk. In other words the risk-premium has to stay the same.
What did we change
From 2016 till the beginning of this year the central bank interest rate was 0, which meant that the risk-free return component in determining our rates was stable. In July 2022 the ECB increased their interest rate for the first time in 11 years. The big question is whether it’s enough. If inflation continues to be high, it is likely that the central banks will keep increasing their rates. Nonetheless, it is expected that at some point central banks will decrease their interest rates too.
Therefore, we have changed the frequency that we review the interest rate that we charge our borrowers and made it easier to update the pricing in our systems. We now have a dedicated pricing committee, consisting of specialists from the different countries that we’re active in. The pricing committee will monthly review what is the relative risk-free interest rate per country and propose a new pricing throughout all countries or for a specific country.
With this approach we’re able to match the responsiveness that the current market environment demands. We’re able to continue agreeing on attractive terms for borrowers and lenders, whether the central bank rates go up or down.