Risk and capital benchmarks: default rates and capital ratios

A BNPL (buy now, pay later) lender books $500 million in loans this quarter. Investors want one number that tells them how much of that book will never get repaid. Across the Atlantic, a European e-money institution processing the same customers' payments has to answer a completely different question: does it hold enough regulatory capital to survive a shock. Both numbers matter. Neither means anything without knowing how to read it.

This lesson builds the two benchmarks fintech professionals get asked about most: the net charge-off rate for lenders, and the capital ratio for regulated payment and e-money firms.

Net charge-off rate: the core lending health metric

The net charge-off (NCO) rate measures the percentage of a loan book written off as uncollectible, minus recoveries, over a period, usually annualized.

Formula:

NCO rate = (Gross charge-offs − Recoveries) / Average loans outstanding

• Gross charge-offs: loans the lender has given up trying to collect.
• Recoveries: money later clawed back (collections agencies, settlements, resold debt).
• Average loans outstanding: the denominator, usually average balance over the quarter or year, not the ending balance, to avoid distortion from fast growth.

Worked example

A BNPL provider reports:

• Gross charge-offs for the quarter: $18 million
• Recoveries: $3 million
• Average loans outstanding: $500 million

NCO rate = ($18M − $3M) / $500M = $15M / $500M = 3.0% (quarterly)

Annualized (rough method: multiply by 4): ~12% annualized NCO rate.

Compare that to a prime credit card issuer, where annualized NCO rates typically sit in the 3% to 5% range (as of 2024 to 2025 estimates, varies by issuer and credit tier). BNPL books skew toward thinner-file or subprime borrowers and shorter loan terms, so higher NCO rates are structurally expected, not automatically a red flag. The benchmark only means something relative to the borrower segment and loan duration.

Why this ratio gets manipulated (or misread)

Growth distorts NCO rates. If a lender doubles originations in a quarter, average loans outstanding balloons, deflating the rate even if underwriting quality is stable or worsening. Always check whether the loan book is growing fast before trusting a low NCO rate at face value. Klarna and Affirm both disclose credit-loss metrics in their public filings and investor materials; Affirm's 10-KKThe average number of new users each existing user generates through referrals. Above 1.0, growth compounds on itself and becomes exponential.View full definition → filings with the SEC are a good primary source for BNPL credit metrics.

Delinquency rate: the leading indicator

NCO rate is backward-looking, it tells you what already went bad. The delinquency rate (share of loans past due, commonly bucketed at 30, 60, 90+ days) is the forward-looking cousin. Rising 30-day delinquencies today often show up as charge-offs two or three quarters later. Analysts watch the delinquency "roll rate" (what share of 30-day-late accounts progress to 60-day-late) as an early warning system.

Crossing the Atlantic: capital ratios for e-money and payment institutions

Now switch lenses. A BNPL lender's core risk is credit risk on its own balance sheet. A European e-money institution (EMI), a firm licensed to issue electronic money and process payments under the EU's Electronic Money Directive (EMD2), doesn't lend depositor funds the way a bank does. Its core risk is operational and liquidity risk: can it always return customer funds on demand.

EMIs and payment institutions (PIs) under the EU's Payment Services Directive (PSD2) must hold own funds (regulatory capital) calculated by one of three methods set by their national regulator (in Ireland, the Central Bank of Ireland; in Lithuania, the Bank of Lithuania; both popular EMI licensing hubs).

Method B (based on payment volume) is common:

Own funds requirement = 4% × (fraction of monthly payment volume, tiered)

Simplified illustration (tiered percentages decline as volume rises, exact bands set by regulator):

• On the first €5 million of monthly payment volume: 4%
• On the next tranche: 2.5%
• Declining further at higher volume bands

Worked example

An EMI processes €50 million in payment volume in a month.

Using a simplified blended rate of roughly 3% across the tiers (illustrative, not a precise regulatory table):

Own funds required ≈ €50M × 3% = €1.5 million

The firm must hold at least that much in eligible own funds (share capital, retained earnings, certain reserves) permanently, not just at license application. Regulators check this on an ongoing basis, and firms that grow fast can find themselves needing capital injections to stay compliant, a common pinch point for scaling EMIs like Revolut in its earlier e-money-only years before it obtained full banking licenses in multiple jurisdictions.

Bank capital ratios: the CET1 benchmark

If the fintech is a licensed bank (a growing number are: Chime partners with bank-charter sponsors in the US; N26 and Revolut hold full banking licenses in the EU), the relevant benchmark shifts again to CET1 ratio (Common Equity Tier 1), the strictest measure of bank capital adequacy under Basel III.

CET1 ratio = CET1 capital / Risk-weighted assets (RWA)

Regulatory minimum under Basel III is 4.5%, but with buffers, most banks target 10% to 13% (estimate, varies by jurisdiction and systemic importance). European neobanks with full licenses, such as N26, disclose CET1 ratios in annual reports filed with BaFin (Germany's financial regulator) or the relevant national authority. US neobank-adjacent players operating through partner banks don't report CET1 themselves; the partner bank does, which is a key structural difference professionals should know when comparing "US fintech" to "EU fintech" capital disclosures.

Reading the two benchmarks side by side

The takeaway for cross-border fintech fluency: US BNPL and consumer lending disclosures center on credit performance (NCO, delinquency), because the risk is default. EU payment and e-money disclosures center on capital adequacy (own funds, CET1), because the regulatory architecture (EMD2, PSD2, Basel III via CRD/CRR) treats safeguarding customer funds, not lending risk, as the primary concern for non-bank payment firms. A firm can look "safe" on one benchmark and be exposed on the other; always check which regulatory category (lender, EMI, PI, licensed bank) you're actually benchmarking.

🎬 [VIDEO: "Bank Capital Requirements Explained (Basel III, CET1)" - https://www.youtube.com/results?search_query=basel+iii+cet1+explained - a clear walkthrough of how CET1 and risk-weighted assets are calculated and why regulators set minimums]

A quick data sanity-check snippet

For anyone pulling public filings into a spreadsheet, a simple check to flag distorted NCO rates:

def flag_growth_distortion(originations_growth_pct, nco_rate_pct):
    """Flags if fast loan growth may be masking true credit risk."""
    if originations_growth_pct > 30 and nco_rate_pct < 5:
        return "Check: rapid growth may be deflating NCO rate denominator"
    return "No obvious distortion flag"

print(flag_growth_distortion(45, 3.2))

This kind of one-line sanity check is standard practice before citing an NCO rate in an investment memo or credit review.

Key Takeaways

• Net charge-off rate = (gross charge-offs − recoveries) / average loans outstanding. Always check loan book growth rate before trusting a low NCO figure.
• BNPL NCO rates typically run higher than prime credit cards (estimate: low teens vs. 3 to 5% annualized), reflecting borrower risk profile, not necessarily weak underwriting.
• EMIs (EU e-money institutions) hold own funds calculated as a percentage of payment volume under EMD2, not credit-risk capital, since their core exposure is operational and liquidity risk.
• CET1 ratio is the bank-grade solvency benchmark (regulatory floor 4.5%, practical target 10%+), relevant once a fintech holds a full banking license, as N26 and Revolut do in parts of Europe.
• Always identify the firm's regulatory category first (lender, EMI, PI, licensed bank): it determines which benchmark actually applies and prevents comparing incompatible metrics across the US and EU.