The concept of peer-to-peer (P2P) lending was first introduced by Zopa from the UK in 2005. With the promise to bypass traditional intermediaries (i.e. the banks and non-bank finance companies), it was a novel model that quickly spread throughout the western economies.
Before long, P2P lending became a global phenomenon with China and India rapidly replicating this model across the countries. According to Chinese data firm Wind Information, there were more than 2,600 P2P platforms in China alone as at end of 2015.
How P2P Lending Works
P2P lending was all the rage with the notion that borrowers and lenders (commonly coined as “Investors” in P2P lending platforms) could effectively cut out the middle man, or the traditional intermediaries.
What this means then is that:
a) borrowers will have access to lower cost of borrowing (achieved through cost savings passed to them via lower operating costs — eg Lending Club’s operating costs are 60% lower than banks); and
b) individual investors will now have access to higher returns (compared with fixed deposit in the banks) by being a lender themselves.
For those who are unfamiliar with this concept, P2P platforms can be seen as “matchmakers” who matchmake individual investors with people who need to borrow money. And hence the term - peer to peer. In its most fundamental form, P2P lending can be one investor lending to 1 borrower, or a pool of investors lending to 1 borrower. Later, with the participation of institutional investors (such as hedge funds and insurance companies), P2P lending subsequently evolved into marketplace lending (for simplicity, I will continue to use the term P2P lending).
Where Is The Next Growth Region
In the western part of the world, notably Europe and America, P2P lending space has since matured; with myriads of ancillary service providers sprouting out in areas such as fraud detection and credit modelling to complement the P2P lending platforms.
On the other end of the world, alternative financing is now widely adapted in China. Notwithstanding that the P2P lending landscape in China is saturated with copycats (some promising, while many others dubious), several prominent players such as Lufax (more about Lufax later) have evolved with success through sustainable operating models and strategic partnerships.
Looking beyond the matured western world and a saturated China market, Southeast Asia naturally becomes a very attractive option— home to a huge population of 620 million people, with a combined GDP of $2.4 trillion in 2013.
Today, however, P2P lending in Southeast Asis is still in a nascent stage: less than 0.1% of all loans are originated through P2P lenders (contrast with 10% in China and 2–3% in UK and USA). Having said that, as Christiaan Kaptein rightly pointed out in his article, most of the structural drivers for P2P lending are currently in place in Southeast Asia — availability of alternative data, efficiency of credit underwriting process, liquidity from the lender perspective and many more. On top of this, the inherent conditions in Southeast Asia are favorable now.
The Conditions In Southeast Asia Are Favorable:
With a diverse market which extends to culture, language and religion, Southeast Asia is a challenging market where a one-size-fits-all strategy is plainly ineffective. Yet, the potential of Southeast Asia market is palpable.
There are 2 key factors:
- Massive and Young Consuming Class
Southeast Asia, represented by ASEAN — a 10-member international body, is the gateway to a massive community of consumers who are entering the “consuming class” each year (about 4–5 million people, the size of Singapore, will be joining the consuming class every year). This is a group of consumers who are experiencing consumerism for the very first time; many of whom are eager to upgrade their lifestyles — such as buying a house, owning a new car etc.
Underpinning the rise of consuming class, a direct result of increasing purchasing power, is job creation and labor productivity. As shown in the charts, 60%-70% of the most populous economies within ASEAN today is in the working age. Principally, with a youthful working class, ASEAN economy is poised to grow with real productivity gains. Productive labor contributes to a thriving economy which in turn drives real disposable income higher.
Further complementing ASEAN’s demographic dividends is rapid urbanisation, guiding more of the population towards high growth sectors where the economy has a comparative advantage in. Current urbanization rate in ASEAN stands at 36%, and with continued growth in GDP and Foreign Direct Investment (FDI), KPMG estimates that the urbanization rate will reach 45% by 2030.
So what do all these statistics and trends mean?
The above phenomenon is a very important ingredient — it creates the demand for consumer goods and hence facilitates financial services to flourish.
For example, a group of young graduates who aspires to own their first cars, and this is perceived to be important especially in cities like Jakarta and Ho Chi Minh where public transport is in dire conditions, will be seeking for auto loan financing, rather than accumulating their savings for a year just to afford the down payment.
This is the beauty of financial services — extending credit to people, who have the financial capacity and character to repay, in order to acquire goods or services for instant gratification.
2. The Unbanked And The Underserved — Opportunities Abound
In Southeast Asia, there is a distinct disparity between the size of the population and people with bank accounts. According to the World Bank’s Global Findex, about 60% of the population in Indonesia, and about 70% in Vietnam do not have a bank account.
So what does this mean?
To appreciate the above statistics, let’s take a step back and understand how the banking system works. In traditional lending, banks rely on individuals’ credit score to derive their creditworthiness, which in turn determines whether to lend them or not.
Now, as mentioned above, a significant fraction of the population in Southeast Asia does not even have a bank account, much less a credit score. This essentially means an outright exclusion of the majority from accessing financial services.
Coupled with a fast-growing consuming class, can you imagine how many people, who now have the capacity to borrow money, will be “unqualified” for taking up a borrowing facility?
And This Is Where P2P Lenders Strive To Bridge The Gap
The banking sector is among one of the most heavily regulated industries. In order to retain their banking licenses, banks have to comply with a set of regulation and guidelines. One of which is the credit underwriting model— majority of the banks, if not all, have to undergo comprehensive and lengthy process of independent validation, stress testing, fine-tuning, monitoring and approvals before a credit model can be revamped.
If you fully understand the situation of the unbanked or underserved consumers, you will know that a major revamp of the credit scoring model is required. This is simply because the current traditional credit model does not cater to the unbanked.
And this is where P2P lenders come in to bridge the gap in Southeast Asia. Just to name a few notable examples of P2P lenders operating in Southeast Asia:
- Funding Societies / Modalku
Category: SME unsecured loans
Key markets: Indonesia and Singapore
Key partners: DBS, Sinarmas Bank
Category: Invoice financing and employee unsecured loans (partnered companies only)
Key market: Indonesia
Key partners: Danamon
Category: Unsecured personal loans
Key market: Vietnam
Key partners: Ministry of Science and Technology (government agency)
Category: Equity Crowdfunding, SME unsecured loans and personal secured loans (more like pawnshops with underlying collaterals such as goldbar, jewellry etc)
Key markets: Singapore, Indonesia, Malaysia
Category: Unsecured personal and business loans
Key market: Philippines
To have an understanding of how the future of P2P lending in Southeast Asia will unfold, it is meaningful to recognize the common denominators of existing P2P lenders. The commonality can be summarized in the following 4 points:
1. Product Focus
Most P2P lending platforms today are focusing largely on unsecured business loans or unsecured personal loans — see the matrix below:
There are 2 key elements to consider— target audience and nature of loans.
(i) Target Audience
Both SMEs, especially the small and micro businesses, and unbanked individuals are way underserved today. Micro businesses generally require small ticket size loan facility which in return generates paltry revenue (compared with a corporate loan in the region of millions of dollars). At the same time, due to the complexity of credit assessment and account servicing, micro businesses demand relatively more resources to manage. The cost/revenue equation may not justify a good ROI, especially if credit losses are not well-compensated.
As for personal loans, unbanked individuals are today excluded completely. This group of people borrows either from friends/relatives, or from loansharks (ie. illegal moneylenders) at absurd rates.
(ii) Nature of loans
Most P2P lenders focus, or at least start with, unsecured lending. Some may ask, why unsecured loans since the risk of credit loss is much higher?
The answer to this lies in the following 3 pointers:
a. P2P Business Model
In a P2P lending model, the company is nothing more than a platform facilitating loan origination. In its most fundamental form, a P2P lender does not assume default risk; the individual and institutional investors who fund the loans take on the entire risk of default. Surely, some P2P lending platforms may claim to have skin-in-the-game by co-investing into the loans, but the principle of passing risks to investors still largely remains.
Wait a minute, if P2P lending platforms do not assume default risks, wouldn’t it make sense to introduce more types of financing? This brings me to my next 2 points below.
b. The Market Is Not Ready To Invest For Long Term
Unlike the matured P2P lending market in US and China, P2P lending is still an untested investment model in Southeast Asia. As such, it is not surprising that many retail investors are apprehensive of putting money through these platforms for long term investments. In fact, most are only ready to invest for short tenor of up to 1 year (majority only 3 months).
This mentality and readiness of market have significant implications. Collateralized loans such as auto loan and mortgage which are medium to long term commitments may not be attractive to average retail investors. Either P2P lending platforms through their networks attract rich retail investors, or they have to securitize the long-term asset-backed loans into short-term promissory notes. Both are not easy to achieve.
c. Collateralized / Secured Loans Are More Complex To Manage
The underlying assumption of secured loan is that it should be a “safer” investment. After all, in the event that the borrower defaults, an investor can always get back the collateral value.
This is only partly true. Why so?
(i) Collateral value, depending at the point of default, may be lower than the outstanding loan amount (especially for auto loans during the first 18 months due to front-loaded vehicle depreciation)
(ii) Not all P2P lending platforms know how to effectively manage a secured loan book. It is a lengthy process of holding on to title of collaterals, tracking of collaterals and recovery of collaterals, provided that the laws in the country even permit. For example, movable collaterals such as cars can easily be smuggled by fraudsters. When this happens, it essentially becomes a fully unsecured loan.
2. Most P2P Lending Platforms Are Operating Under Unclear Regulation
In most countries within Southeast Asia such as Indonesia, Vietnam and Cambodia, there are no specific provisions on P2P lending. While this situation creates uncertainty, it also gives the players greater maneuverability.
Today, in most countries, P2P lenders are legally construed to be a technology platform.This is critical as it would then mean P2P lenders will not be bounded by the shackles of far-reaching regulations and compliance that are applicable to credit institutions or banks.
One key benefit is undoubtedly lower cost. Compliance to financial regulations are complex, expensive and time-consuming.
Another key benefit is that P2P lenders have the freedom to design and implement credit models that make use of non-traditional data sources such as utility, telcom, social media and mobile data to assess the creditworthiness of the unbanked. All these can be achieved without explicit approvals from regulators. Nimbleness that the banks can only envy.
3. None Of The Credit Models Used By The P2P Lenders Today Are Truly Tested
This is not new; many articles have openly criticized that the credit models adopted by P2P lenders are, at best, effective in assessing borrowers during the “good times”.
In Southeast Asia, at least, there is no one P2P credit model that has undergone the full credit cycle which includes, economy boom and recession or downturn.
Moreover, the credit assessment methodologies are varied and diverse. Most rely on fully rule-based assessment (or what I would like to call programme-lending), while others rely on a mix of rule-based and discretionary credit assessment. Which is more effective, no one knows till we see the turn in credit cycle.
4. Customer Selection: Bottom-Of-Pyramid Or Near-Prime
Have you ever noticed that the vision and mission of almost all P2P lenders in the market are about serving the “underserved” or “unbanked” population? Why are they not targeting the so-called prime customers?
There are 2 key reasons:
a. P2P Lenders Cannot Compete With The Banks
Prime customers are the bread and butter of mainstream banks. By definition, this group of customers are considered to be the least risky, providing good risk-return investment for the banks.
In any heavily regulated industry, such as telecommunications and healthcare, you will see that disruptors typically target the least profitable products or customer segments— segments that the incumbents couldn’t care less about serving. If a disruptor were to target the most profitable segment, incumbents, with all their financial and political might, will start lobbying or working together to get rid of the challenger. And this is especially true in the banking sector.
Another reason is that prime customers today are very entrenched in traditional banking . Surely there are rooms for improvements from customer experience to customer service, from product design to marketing campaigns. But traditional banking has created an ecosystem where one service is supported or overlaid by another. This ecosystem is large, comprehensive and solid that customers find it sticky to switch to a new provider if value creation is not significantly outweighing the opportunity cost of status quo.
Imagine a P2P lender today were to start targeting the prime customers for personal loan, taking at least 200 basis points off the current bank interest rates. Banks will immediately retaliate by (a) heavy marketing, or (b) bundling to offer superior offers, or (c) lobbying against the P2P lender by attacking its weak, untested credit model. Before long, public may lose faith of the P2P lender or regulator may even intervene.
b. P2P Lending Model Inherently Has To Target High Yield Customers, For A Start
Inherently, a P2P lending model is not only serving the borrowers. Another part of the equation is investors — both retail and institutional.
Amount of loans originated = Amount of funds from retail investors + Amount of funds from institutional investors
In the long run, funds from the investors are much more crucial. After all, the amount of funds determines the amount of loans that can be originated to borrowers.
When a P2P lender scales, to continue its momentum, huge amount of liquidity and capital will be required to originate new loans. To attract capital from investors, the yield or returns have to be substantially higher than what fixed deposit in the banks can offer (at the very least).
What this means is that the segment cannot be prime customers; no prime customer will be willing to pay higher interest rates if they are eligible for bank loans. Naturally, we are looking at one tier lower than prime customers, provided the P2P lender does right in its profiling and targeting of customers. Otherwise, negative selection of customers will happen.
So how will the future of P2P lending look like in the next 5 years?
“I very frequently get the question: ‘what’s going to change in the next 10 years?’ And that is a very interesting question; it’s a very common one. I almost never get the question: ‘what’s not going to change in the next 10 years?’ And I submit to you that the second question is actually the more important of the two — because you can build a business strategy around things that are stable in time… in our retail business, we know that customers want low prices and I know that’s going to be true 10 years from now. They want fast delivery; they want fast selection. It’s impossible to imagine a future 10 years from now where a customer comes up and says, ‘Jeff I love Amazon, I just wishes the prices were a little higher [or] I love Amazon, I just wish you’d deliver a little more slowly.” — Jeff Bezos
As what Jeff Bezos (CEO of Amazon in case you are still wondering who he is) advises, what’s often more important is what stays the same. I believe the following trends will continue in the next 5 years:
1. Banks Will Continue Focusing On The Prime Customers
Southeast Asia’s sweet spot lies in its rapidly growing middle class (projected by AC Nielsen to reach 400 million by 2020). In other words, the population of prime customers will rise as fast as its middle class growth.
With a large and growing middle class qualifying as prime customers, the pool will only get bigger. This has important implication: the prime market will not be saturated, in fact it will only get larger. With its lucrative segment expanding, in the next 5–10 years, banks will stay focus and not enter the bottom-of-pyramid segments where P2P lenders aim to target.
2. Partnership With Banks Will Intensify
The term “Fintech”, which means financial technology, is one of the most ubiquitous buzzwords in the startup scene. To some, Fintech, which naturally includes P2P lending, resembles the battle where small and agile David slays large and mighty Goliath. Or putting it in other words, tech will be “eating” the lunch of banks, rapidly replacing them through unbundling of financial services. But the truth can be quite the opposite and definitely much more interesting.
“Banking is necessary, banks are not.” — Bill Gates
Hailed as disruptive forces equipped with the latest technology, ideology and business models to challenge the incumbents in the financial world, many Fintechs believe they are here to upend the various different niches in finance. After all, free from legacy systems and processes, Fintechs are nimble enough to spot trends, identify gaps in the market, and responding quickly to customers. While there are truths to the claims above, proponents of fintechs are oversimplifying what’s going on, with an obscene discredit of what the incumbents have achieved over the decades.
Partnership with banks will intensify in the near future and these are the reasons why:
a) Long History Of Banks, An Element Of Trust
To get a more definite picture of the current wave of fintech obsession, we must first understand the position of banks in the larger scheme of things. In Southeast Asia, banks have been around for decades, establishing key infrastructure, developing ecosystem and network effects, and perhaps most importantly, building trust with consumers (Source: Tech Crunch).
Today when you deposit money in a bank , you trust that the money is accurately, exactly and promptly reflected in your bank account. Today when you swipe your credit card, you trust that the transaction goes through based on the approved credit limit given to you. These are what trust is all about, built upon extensive network effects (with key partners such as payment gateways, insurance companies etc), reliable infrastructure, and sound regulatory compliance.
Unlike other startups, scaling in fintechs hence takes on a different meaning: building trust. Fintechs, while promise a better way of banking, are only starting to develop infrastructures and network effects where majority has not even reached a vintage of 5 years in business. And this applies no less to P2P lending. In fact, P2P lending has a long way to go in terms of building trust — thanks to ponzi schemes and frauds in prominent cases such Ezubao.
b) Banks Hold Huge Pool Of Resources
According to The Banker, top 10 ASEAN banks collectively brought home more than $24.50 billion of pre-tax profits in 2014. This statistics visibly provides an indication of the scale and size of resources that banks have.
Perhaps more importantly, banks are also the gate-keeper to the financial ecosystem where the right to participate becomes a scarce resource. To illustrate this, take the example of P2P lending. The biggest challenge faced by many P2P lenders comes when they scaled up — the access to sufficient pool of investors.
Unique to P2P lenders, they do not lend out from their balance sheets and they do not take in deposits. What this means is that liquidity becomes increasingly crucial when there are more and more borrowers requesting for funds, yet growing the number of investors to provide the liquidity and capital gets tougher. If you understand the business model of P2P lending, you will know that the ability to churn as many cycles of matching borrowers with investors ultimately determines profitability. And banks have access to all these investors; alternatively banks, with its immense pool of financial resources, can provide liquidity by absorbing into their loan books.
In Southeast Asia, we do not see any sizable P2P lender at this point in time. For illustration, Funding Societies (Modalku) and Investree are probably two of the most established P2P lenders in Indonesia — based on their websites (screenshots below), portfolio size ranges between USD 2–3 million.
To scale faster, we are likely to see partnerships with banks becoming ubiquitous. And I’m talking about meaningful partnerships where banks play a much active role in originating loans, securitizing loan portfolio, and even distributing of loans.
Partnerships such as the one between DBS and Moolahsense and Funding Societies (referral partnership) will become more common, but less important. Eventually the first few P2P lenders with key partnerships in areas of loan origination or securitization are likely to consolidate their market shares within the next 5 years.
While we might see more arm-length partnerships between P2P lending platforms and banks, M&As may still be an unlikely outcome, at least in the next 5 years. Even in the US and China markets, acquisitions of fintechs, in particular P2P lending, have been slow. Partnerships, rather than M&A targets, have been extremely helpful to banks which have been squeezed out of some financial services. They keep themselves in the game and staying relevant, without taking on huge risks.
c) Regulations Will Still Be The Biggest Hurdle That P2P Lenders Need To Overcome
Regulations are essential in the financial world — they ensure the delivery of consumer protection and stability in the financial system. As such, we can expect many regulators to be keen in regulating P2P lenders. This is the case in the US market, where P2P lenders follow stringent and comprehensive regulatory process. In fact it is mandatory to regulated by the Securities and Exchange Commission.
Today, many ASEAN countries do not have specific regulations governing P2P lending, including Vietnam and Indonesia. Most regulators are adopting a wait-and-see approach since none of the P2P lenders are huge enough to cause chaos or instability to their financial systems in the event of failure. In the short-term, such uncertainty provides P2P lenders the freedom; to be sustainable, however, P2P lenders need to scale within the boundary, and clarity will be extremely critical.
At the forefront of fintech revolution, Singapore has recently published guidelines on P2P lending. In the guidelines, P2P lenders are not classified as financial institutions nor required to comply with industry-specific rules.
Read more from: The Jakarta Post http://www.thejakartapost.com/academia/2016/06/13/regulating-peer-to-peer-lending-businesses.html
While regulators within ASEAN are experimenting P2P lending, this wait-and-see approach may soon come to an end, especially since they can now take reference from Singapore guidelines. In the near future, we expect more ASEAN countries to announce their set of guidelines on crowdfunding and P2P lending. Being a closely knitted economic market, we can expect the guidelines to be structurally similar from one another within ASEAN.
Firstly, this implies that existing P2P lenders who are currently operating in Singapore will have an advantage in complying with the regulations in the future. They are given a headstart to navigate within the regulatory boundary.
Secondly, with greater compliance comes greater cost. One of the key value propositions of P2P lending lies in its low operating cost. With compliance cost in the picture, we can expect profitability of many P2P lenders to shrink. Those who fail to partner with banks face the brunt of reality — rising compliance costs coupled with the stress to attract capital and liquidity.
So Knowing What Will Stay, Do We Know What Are Currently Missing?
As the P2P lending landscape takes shape, there are still several major missing pieces that have yet to fall in place. Those who can identify and fill up the gaps eventually win big-time.
So, what are the missing pieces?
1. Expansion Of P2P Products
As discussed earlier, P2P products today are focused primarily on SME borrowings and unsecured loans. These loans are short-term and high risk, with personal guarantee as the only source of recourse.
For the P2P marketplace to mature, there needs to be an expansion of products to cater to a wider range of investors with varying objectives. P2P lenders who are able to crack asset-backed financing (eg auto loan financing and mortgage loan) will have an advantage. This is not easy because:
a) Tenor (typically 3–5 years for auto loan or beyond 5 years for mortgage loan) is longer than what the market can possibly accept in the next 5 years; and
b) Asset-financing requires specialized expertise in credit management, risk monitoring and recovery of collaterals. World-renowned Lending Club has only recently entered into auto loans after years of running P2P business, and even so, the focus is only on refinancing.
2. Evolution Into A Marketplace, Truly
Lufax, one of the most successful financial marketplaces in China, started its operation in 2012 as solely a P2P lending platform. Backed and owned by Ping An Bank, Lufax today grows into a marketplace where financial products beyond P2P products are listed by asset providers from diverse financial institutions on the platform. Valued at $18.5 billion, Lufax shows how P2P lending platforms can successfully evolve as they scale.
The above can only happen where we see partnership between banks and P2P lenders deepens. In the next couple of years, I do not foresee any P2P lenders emerging as successfully as Lufax, simply because the P2P business model and landscape are still in their infancy stage. Having said that, I believe in the matured stage of P2P lending in ASEAN, we will eventually arrive at similar state as Lufax, hopefully within the next 10 years.
3. Expertise In Non-Traditional Credit Model
Presently, credit models used by P2P lenders in ASEAN are not scrutinized by the regulators nor the consumers. The market is still in an experimental stage where mistakes are largely forgiven. Also, with most P2P players only sprouting out in the last 2–3 years, the market has yet to see major defaults occurring — which are inordinately central to back-testing of credit models.
In the next 5 years, we might be able to separate the bad apples from the good ones, when defaults start rising. This period will then put the so-called credit models deployed by P2P lenders into real test.
Having said that, I believe many P2P players have already realized that collection of non-traditional data sources will be extremely crucial — for more accurate modelling and targeting of customers.
Until the day where P2P lenders are able to stress-test their credit models in a complete credit cycle, the P2P lending market is still a long way from becoming mainstream alternative financing channel.
In conclusion, P2P lending as an alternative financing option will be an important development in the financial world. The role P2P lending plays will be, and rightfully so, to serve those unbanked population which is excluded from traditional banking. This can only be achieved through building non-traditional credit model, partnering with banks or other financial institutions, and expanding the product offering beyond unsecured loans or SME facilities.