Alternative SME financing in Asia Pacific to grow two or more times by 2022
By Chris Kapfer
Licensed digital banks and P2P/marketplace platforms focused on alternative business lending to SMEs are overcoming operating and market challenges to scale and sustain their businesses. Leading players are charging ahead with more comprehensive service solutions and expanding regionally.
Across Asia-Pacific, the volume of alternative financing provided to small and medium sized enterprises (SMEs) reached an all-time high of $4.3 billion in 2019 before falling slightly back to $4.2 billion in 2020 amid the start of the COVID-19 pandemic. This according to the Cambridge Centre for Alternative Finance (CCAF). Alternative SME financing is expected to return to the same level in 2022, particularly in Southeast Asia which makes up more than 50% of volumes in Asia Pacific.
Consumer lending provided through peer-to-peer (P2P), preferrably known as markerplace platforms, is the most popular form of alternative financing. This is followed by lending to businesses and SMEs. Indonesia and Japan are the leading markets for marketplace business lending to SMEs. Alternative business lending start-ups in Indonesia attracted the most funding and secured the highest number of deals of any fintech segment. Malaysia has seen strong growth in marketplace business lending since 2020. Overall alternative financing figures however remain minuscule as compared to traditional SME bank lending volumes. For example, the combined alternative business lending in Indonesia accounted for only 0.39% of total outstanding SME bank loan balances in 2020.
Marketplace and P2P platforms in particular have been struggling to shake off the bad reputation of high investment risk and fraud, especially in China where regulatory crackdowns following a number of platform collapses decimated the entire sector. By mid-November 2020, the number of P2P lenders in the country dropped from a peak of 5,970 in 2017 to zero. To survive, they were forced en bloc to pivot from loan issuance to loan facilitation platforms without the ability to raise or invest their own capital anymore. In markets like Singapore, the pool of platform lenders shrunk from as many as 15 to less than five in the last few years.
For the larger and more established marketplace platforms (see figure 2 below), their business lending has been maturing in the last years to include more secured forms of lending such as supply chain financing. As they grow, they are reinvesting earnings into expanding value-added services beyond financing. Few platforms however operate across different Asia-Pacific markets, the majority operate in one or few markets. They are also looking to bring more specific value propositions to certain industry verticals, a strategic move not seen prior to the pandemic. They have the potential to evolve over time into more comprehensive digital SME banks.
In 2021, KoinWorks launched its NEO platform, specifically designed for SMEs, offering virtual cards to carry out important digital procurement transactions such as purchase of business equipment or paying for advertising on social media. Users can also access budgeting and accounting solutions for their business. At the end of 2020, Indonesian ride-hailing unicorn GoJek acquired a 22% stake in Indonesia’s Bank Jago while Indonesian P2P lender Amartha is reportedly in talks to acquire 70% of local Islamic bank Bank Victoria Syariah to turn them into digital banks.
On the funding side, leading business lending marketplaces have created a balanced mix of private and institutional investors and were able to raise further capital in 2021. After a decline in 2020 and muted growth in 2021, most are eyeing growth on the scale of between two and four times beyond 2022.
The business model of marketplace business lenders stands in stark contrast to banks. They offer a fully digital-application based lending service, although the level of backoffice automation varies widely. By contrast, SME banking is mostly relationship-based where managers look for deals and bring them back to the bank to be processed, where they will be handed over to the credit team. This whole model works well for medium-sized businesses but falls apart for smaller and micro-sized enterprises. The cost to acquire and maintain the account coupled with weak or non-existing access to public credit data make it commercially unviable to serve them. Banks in markets like Hong Kong, South Korea and Taiwan have made more meaningful efforts in recent years in catering to smaller SMEs enabled by improved digital capacities, but for banks in most emerging markets in the Asia Pacific the micro,small and medium-sized enterprise (MSME) sector is minuscule. In the Philippines, corporate loans contribute 73% of total outstanding bank loans while the portion of MSME loans is below 10%, with the rest in retail lending.
Partially to blame for this is the enormous data gap that hinders proper credit evaluation of smaller SMEs, which is equally applicable to mature markets in Asia Pacific.
In Singapore for instance, SMEs under SGD10 million ($7.3 million) in turnover do not have to be audited and the level of corporate credit information is very low. For this smaller segment, banks have not cracked the credit data challenge, though there are nascent steps taken to share data from telcos and e-commerce providers to narrow the gap. Banks have been making a move into smaller SME financing with loan size of up to $250,000 but such uncollateralised loan instruments are available to existing SME customers only.
Markeplaces and digital banks that are focused on smaller SMEs aren’t better off in this regard, in fact, it’s worse. Neither do they have access to transactional client-bank data nor do they have large scale proprietary ecosystems that can generate cash flow information at their disposal. Thus, they mainly partner with larger corporate anchors and their SME-sized suppliers and/or distributors, focusing on the least risky financing instruments such as invoice financing rather than purchase order or clean working capital financing. The ability to onboard big-name corporates in this game is critical.
But it is this particular area of data management that leading marketplaces and digital SME banks today have built their strength vis a vis banks. It is not fancy apps or frontend user experience but the innovative use of data, credit underwriting models and fast turnaround time that distinguish the alternative financing players. While marketplaces have started out by assessing a mix of traditional financial statements, cash flow and personal credit bureau reports, they have reduced their reliance on these as they progressed. They have reduced the weightage of traditional financial statements and increased the portion of non-financial data. It is a false assumption that the heavy losses the industry suffered in China originated on the credit side. The majority of losses incurred in the past came from outright fraud and mismanagement. Today, for example, the average 90+ charge-off rate for SME loans in China is around 4% to 5%, while leading business lending marketplaces manage to maintain at a significantly lower level of under 3%.
Digital SME banks pose less of a market threat to incumbents than their digital peers in retail financial services
Like marketplaces, the emergence of digital SME banks since 2018 in Asia, outside China has been facilitated by regulatory policy to address market inefficiencies and promote financial inclusion. In Hong Kong for instance, there are around 340,000 MSMEs and more than 160 banks, yet more than 40% of Hong Kong’s 2,200 non-bank money lenders serve the MSME sector.
In Asia Pacific, digital lenders that are focused primarily on SMEs, with licences in wholesale banking have seen much slower traction compared to their digital peers in retail financial services.
There are only seven digital banks focused on SMEs in the region. They are concentrated in Australia, Singapore, China and Hong Kong. Mybank China, which is the digital banking arm of Ant Financial Group, caters mainly to merchants in the Alibaba e-commerce segment, has grown its book since 2015 to $20 billion and has a client base of 35.1 million. It is also the only profitable digital SME bank. The technology they use enables superior efficiency in account opening, account maintenance and the loan approval process. It is also ahead in building out an integrated product and service platform by partnering with customer-focused businesses.
While leading commercial banks have progressed well to narrow some of these gaps since the pandemic but differences remain. In Australia, traditional bankers would have to contend with between 10 and 20 systems to perform their daily functions which impact on overall customer experience and operational efficiency. Judo Bank Australia which is the largest digital SME bank by outstanding balances in Asia Pacific excluding China has set up one ecosystem where all data flows from front to back. The bank also established a real-time dashboard that allows customers, bankers and brokers to collaborate.
Even with $2.5 billion in outstanding balances as of 2021, Judo Bnk would need to reach at least the scale of $10 to $15 billion to sustain itself. By comparison, NAB Australia has an SME book of $88 billion.
Scale is not the only hurdle for digital SME banks. It is also doubtful that they will attract medium or larger SMEs, the core segment of commercial banks, because of their low capital base and inability to underwrite larger loans. The deposit business in SME banking is critical and digital banks are still figuring out how to address the funding challenge.
Digital SME banks are very different compared to traditional commercial banks not only in IT architecture and customer segments they serve but also in risk culture. Commercial banks are highly regulated entities with low margins and big balance sheets to drive profitability. Startup digital SME banks on the other hand are not expected to be profitable, at least in the first five years of operations. It is not without good reason why the regulator in Singapore has asked these digital wholesale banks to have a clear exit strategy.
Digital SME banks may face bigger challenges ahead compared to business lending marketplaces
Digital SME banks have been making some inroads in niche areas such as business payments and forex services but have a long way to go to equal the depth of products, services and advice provided by SME banks. The way they build their relationship management approach will be interesting to watch in the next years. They will face fierce competition from established commercial banks which have increasingly played a more meaningful role in the early stages of the SME lifecycle, as well as from digital consumer banks that are expanding their offer to micro and small businesses and digital business specialists (e.g. bookkeeping and tax apps).
Compared to a few thousand clients for digital SME banks in the Asia Pacific, marketplace business lenders have a much larger customer base to build comprehensive integrated beyond banking solutions for. They in turn will also generate a huge volume of proprietary data that can be leveraged on. As they are not deposit-taking institution, they have no access to large scale lendable funds to challenge traditional lenders. This may over time drive some of them to apply for a digital SME bank licence in order to compete. Moreover, alternative lenders that previously focused on individual credit are also expanding into small business lending. Webank, known for its micro-loan business to individuals, has been building its enterprise platform Webank Enterprise+ since 2017. Some of these platforms have a more visible path to profitability than digital SME banks. Business lending marketplaces have suffered a lot in credibility in the last five years and rebuilding this trust is critical in gaining further scale