The Heli-Pad: Issue II | 12 March 2020
In the first issue of The Heli-Pad, we introduced the concept of alternative lending as any lending practice that happens outside a traditional banking institution. We also made the distinction between traditional alternative lenders such as microfinance institutions, leasing and financing companies, and FinTech/digital lenders such as Peer-to-Peer (P2P) lending platforms and technology-driven lenders providing loans directly from their balance sheet.
In this issue of The Heli-Pad, we focus on digital lenders in Southeast Asia (SEA) and explain why these originators are rapidly closing the gap versus their traditional lending peers.
While most tech-enabled alternative lenders in SEA are less than 10 years old, the larger platforms have been strengthening their position as a disruptor of traditional bank financing models thanks to technological innovation, high mobile usage, and increasing internet access. Their main differentiator from traditional alternative lenders has been their ability to leverage millions of alternative data points from loan applicants to strengthen their underwriting processes and shrink disbursement timelines.
As a result, digital loan originators are quickly becoming an important enabler of financial access for MSMEs, individuals, and micro-entrepreneurs who have been long underserved by traditional banks, especially for those located in more rural or remote locations.
Figure 1: Balance Sheet Lending vs Peer to Peer Lending
A growth in digital financial services – with digital lending leading the way
Enabled by technology, digital financial services (Payments, Remittances, Lending, Investments, and Insurance) have the potential to increase access, reduce costs, and deliver more inclusive financial opportunities for all Southeast Asians, particularly for the large numbers of underbanked and unbanked individuals. According to the “Future of Fintech in Southeast Asia” report in 2020, there are 570 million people and 360 million internet users in SEA, yet as many as 50% of the region’s consumers are unbanked, and 70% are either underbanked or unbanked, which provides a huge market opportunity for further growth in digital financial services.
According to the “e-Conomy SEA 2019” study led by Google, Temasek and Bain & Co, digital lending was the largest contributor to digital financial services in the region by dollar value in 2019, and it was expected to remain the largest contributor to digital financial services by 2025 (see Figure 2).
Figure 2: Pre-COVID 19 SEA Digital Financial Services Growth Projections (US$ Billion)
Source: ‘e-Conomy SEA 2019’
In 2020, as COVID-19 moved consumers and business online, digital financial services including remittances and investments saw higher than expected adoption rates. The updated “e-Conomy SEA 2020” states that digital investments AUM increased by 116% from 2019 to 2020 primarily driven by Robo-Advisors and Online Wealth Management platforms (see Figure 3).
Figure 3: Post-COVID 19 SEA Digital Financial Services Growth Projections (US$ Billion)
Source: ‘e-Conomy SEA 2020’
While COVID-19 pressed the breaks on digital lending in the first half of 2020 (read further on the impact of the pandemic in the following section) resulting in flatline growth for the full year, the projection remains for digital lending to see the steepest growth among digital financial services with loan book volumes quadrupling by 2025.
This growth projection is driven by the following factors:
- The largest digital platforms have lowered the main barriers to entry on the demand side (KYC, customer identification and verification processes).
- While banks rely on traditional credit data and in-person meetings, digital lenders enable last-mile distribution especially for those located in rural and remote areas. This is done through digitally enabled points of access such as mobile phones and point-of-sale (POS) devices.
- Digital lenders are able to collect and analyze alternative data points, such as payment transactions and telecom data. Alternative data analysis then enables credit assessment and pricing for borrowers with little or no formal credit history. It also improves customer profiling and fraud detection.
- When operating at scale, digital lenders should be able to achieve significant cost savings which would ultimately translate into lower borrowing costs.
Figure 4: What is Alternative Data
It is important to note here that the digital lending landscape across SEA remains quite fragmented and not all digital lenders are created equal. Below are some broad caveats that users of digital lending platforms should be aware of, especially as government regulation is still playing catch-up in many ASEAN jurisdictions (Indonesia, Malaysia and Singapore have clear regulations on P2P lending, Thailand has issued a consultation paper, while the Philippines and Vietnam are still at the nascent stage with few players currently operating locally):
- Given the ease of setting up digital interfaces, unlicensed lenders have sprouted, and some have adopted predatory practices. For example, in Indonesia, the Financial Services Authority’s Investment Watch Task Force has handled 2,591 illegal P2P lenders and suspended the operations of 99 unlicensed lenders since 2018. Many of these lenders had duplicated the websites of licensed companies to create the impression that they operate with proper licensing.
- In the absence of personal data regulation in certain jurisdictions, users can end up consenting to broad access by digital lenders to their phone book, text messages, photo gallery, or location and therefore risking misuse of that information.
- Some digital lenders are not living up to their promises in terms of integrity of underwriting as they place more emphasis on growth plans, resulting in riskier loan book profiles which can threaten the entire platform’s solvency.
Given that the combination of product misunderstanding, ease of access, and user-friendly interfaces can lead to borrower over-indebtedness and malpractice by originators, borrowers are highly advised to research the legitimacy of digital lenders and to ensure that they understand the terms and conditions attached to their financing product. In addition, users of digital lending services should be well informed on how digital platforms safeguard their personal information.
How COVID-19 is impacting Alternative Lending in SEA
When the COVID-19 pandemic hit and lockdowns were imposed across the region, most segments of the real economy were impacted, and especially Small and Medium Enterprises (SMEs). Banking facilities, which were too stringent and time-consuming even before COVID-19 for a large portion of small businesses, became near impossible due to growing liquidity challenges and delayed receivables.
Alternative loan originators also took swift action to curb the impact of COVID-19 on their loan books, imposing strict underwriting criteria in Q1, 2020. As a result, origination volumes plummeted in Q2 and Q3 of 2020, and the size of outstanding loan books decreased as originators prioritized collection efforts and allowed disbursements to select prime borrowers only.
Originators simultaneously faced an increase in arrears on their existing loan books, leading to a double whammy on their Non-Performing Loan (NPL) ratios. These developments led to a liquidity crisis for the weaker digital lenders with lower quality loan books, with several forced to cease operations and exit the industry. Consolidation also became inevitable in an uneven industry as smaller platforms were acquired, as seen in the examples of Empatkali and Minterest.
On the other hand, larger originators with strong balance sheets and proactive risk management measures were able to tide through the pandemic successfully, turning the threats posed by COVID-19 into an opportunity to strengthen their leadership positions and improve their internal processes. As they start to scale up disbursements again and expand into new geographies and product segments, we expect the larger platforms to continue to grow faster than their peers in 2021.
Figure 5: Top 5 Digital Lenders in SEA by Funding Raised
Source: Company Disclosures/Crunchbase
Going forward into a post-pandemic world, and given the projected growth of digital financial services, inter-collaboration among governments, traditional banks, and alternative lenders will play a crucial role in driving economic recovery, and particularly at the SME level (SMEs account for between 88.8% and 99.9% total establishments in ASEAN member states and between 51.7% and 97.2% of total employment).
By Q4 2020, the larger and more established digital lending platforms were already offering lifeline financing to MSMEs and enabling a recovery in consumer spending. Many of these platforms have raised fresh rounds of financing to be extended as debt facilities. One important factor enabling these platforms to raise funds has been investors’ increasing appetite for higher returns in a low-yield environment, and their growing levels of comfort with the underwriting processes undertaken by the more established digital lending platforms.
For example, SME digital financing platform Funding Societies disbursed USD630 million within 2020, despite the pandemic. More than 65,000 SMEs in Singapore, Malaysia and Indonesia have received access to funding from the FinTech platform that they were otherwise unable to receive from traditional financial institutions.
On the consumer financing side, Indonesian digital credit platform Kredivo closed a USD100 million credit line with Victory Park Capital, a private credit specialist headquartered in Chicago. This debt facility of up to USD100 million is Victory Park Capital’s first investment in Southeast Asia and will be channeled to Kredivo users.
In addition, with COVID-19 accelerating the adoption of digital financial services, collaboration between FinTechs and traditional financial institutions will enable faster transactions and scalability across multiple channels. For instance, Mastercard and the Asian Development Bank, with partners Finastra, N-Frnds and SGeBIZ, have launched a project to help build a new digital pathway to credit for wholesalers. Through the application of technology, the program aims to help SMEs digitize trade, making it easier for them to participate in global supply chains. The program will start in Indonesia with 500 retailers and aims to build to 5,000 retailers by the end of Q1 2021.
While further regulation of digital lenders will most likely be forthcoming given the industry’s expected growth projections in SEA, such oversight will serve to weed out bad players and enhance confidence in the quality of loan origination, thus attracting more investment into the space.
For this second issue of The Heli-Pad, we have curated a selection of recent press picks to keep you updated on the latest fundraising deals and developments in Asia’s alternative lending space. Happy Reading!