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Analysis: Creating space for banks, fintech to collaborate
New technology is disrupting long-existing companies and conventional industries, but it is also fueling many start-ups, particularly digital ones, that serve in various areas
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ew technology is disrupting long-existing companies and conventional industries, but it is also fueling many start-ups, particularly digital ones, that serve in various areas. Some of them have grown into so-called unicorns, or start-up companies valued at more than US$ 1 billion.
At the moment, Indonesia has four unicorns, namely Go-Jek, Tokopedia, Traveloka and Bukalapak, especially after injections of large amounts of funding from foreign investors.
What about start-ups with financial services technology (fintech)? Although a fintech unicorn has yet to emerge, growth in the sector is quite rapid.
There are two large groups of fintech firms based on their business activities, namely peer-to-peer (P2P) lending and payment services. Both types of activities are starting to disrupt existing financial services available at conventional financial institutions, such as banks, multifinance companies and insurers.
Take, for example, P2P lending services. The funds channeled through P2P lending platforms so far this year reached Rp 1.6 trillion (US$112 million) as of September 2017. Approaching the end of the year, the amount has increased to Rp 1.9 trillion, fifteen times as high as in 2016.
Aside from transactions, the number of P2P lending service providers also increased. There are currently 25 P2P lending companies registered with the Financial Services Authority (OJK), while 33 firms are in the process of registering and 27 have submitted their interest to register.
The P2P lending companies are smart enough to spot financing opportunities in the market. A dominant model in their portfolios is short-term loans, which are usually given to business-to-business (B2B) small entrepreneurs wishing to upscale their business, such as design, advertising and other creative industries.
Generally, those entrepreneurs are already bank customers, despite being categorized as owners of micro-sized businesses. At the same time, they often run into difficulties when seeking financing from banks to increase their business scale, as their assets are insufficient to be considered as loan collateral.
Businesses operating for less than two years are often the target of P2P lending companies, as they are considered ineligible for bank loans. This type of business owner is a kind of blind spot banks have overlooked, prompting P2P lending companies to seize on the niche market by providing working capital, typically in the form of invoice financing.
Invoice financing is a kind of alternative financing with invoices as guarantee for the loan, which can be used to cover operating costs, such as payroll, rent and electricity. The financing can also be used to support business owners in starting additional projects.
In essence, invoice financing helps business owners gain flexibility in managing their cash flow, while P2P lending companies receive administration fees and gain interest income. P2P lending service providers use some of the fee income to cover the premiums for insurance against credit risks should their customers file for default.
How should banks, for their part, react to the growth of P2P lending companies? First, we should bear in mind that there are significant differences in terms of funding supply, even though they have customers of relatively similar characteristics.
In the banking industry, the third party, or customers, are the ones who supply funding, both for investment and operational purposes. It is purely the bank’s decision how to disburse those funds in the form of loans, while customers, despite being the owners of the money, are not involved in the process. Hence, banks are entirely responsible for any risk arising from the loans they disburse.
Consequently, banks will be very cautious in loan disbursement, making collateral requirement highly important and customer screening are multi-layered process to minimize credit risks.
In the P2P lending business model, fund suppliers are lenders who directly channel funds to borrowers through any P2P lending platform that suites their risk appetite. Thus, the owners of the funds, or lenders, are the ones who bear the greatest default risk, rather than the companies running the lending platforms. Under these conditions, P2P lending players are more flexible in channeling funds to prospective markets, as they require less collateral.
Considering each of their strengths and weaknesses, banks and P2P lending players can collaborate in the financing area. One way to do this is by using a scheme called white label partnership, in which banks cooperate with P2P lending players through co-branding products. With their large databases, banks can refer their customers ineligible for bank loans to P2P lending players and receive referral fees in return.
As regulations allow institutions to act as lenders, banks can also disburse their loans through P2P lending companies, making them a distribution channel. For banks, this method will reduce their fees incurred from acquiring new customers.
About 70 percent of P2P lenders are young, ranging in age from 18 to 35 years. This is an opportunity for banks to offer retail investment products with only small initial funds required, which will be more in line with the millenial generation. It will help banks lower the cost of opening distribution channel, as their products can reach more customers in cheaper, easier and quicker ways. P2P lending players, meanwhile, will see their fee-based income increase.
In addition to that, collaboration between banks and P2P lending players can help bank customers who have potential non-performing loans, but are running viable businesses. P2P lending companies can provide financing to these business owners to help increase their flexibility in cash flow management, both for debts and operational payments. However, it needs a special agreement in that regard, in which, for example, banks do not need to charge referral fees to P2P lending players, so that the latter can assist the former in restructuring their customers’ debt obligations.
Going forward, banks and P2P lending players should optimize their respective financing potential by utilizing the larger business ecosystem. For example, they can work with marketplace providers to capture the entire supply chain potential for financing. With clear identification of the businesses in the supply chains, banks and P2P lending companies will be more secured in disbursing their financing.
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The writer is a researcher at the Mandiri Institute.
