Securing Unsecured Loans, 10x

Imagine that you provide loans to 400 small businesses … and your clients are doubling each month.

To make it more exciting: All your loans are unsecured loans, they have no collateral to back them; 98% of your businesses are informal; They are not formally registered as a business; and almost all your clients have no real bookkeeping system.

Sounds pretty scary…? Well this is my line of business, it is a very necessary business. At Mekar.id we finance small businesses in Indonesia that can’t get access to bank nor venture capital finance.
Mekar’s loans are risky, but so far have only 10 loans with late payments, at worst they’re 11 days late. We’ve been in operation for 5 months, and our loan portfolio is more than doubling every month. So yes, we need to do something about securing these unsecured loans.

Mekar ( https://mekar.id ) means ‘to blossom’ in Indonesian. We take pride in doing things differently, such as offering unsecured loans. And there’s a big upside — we do business loans more efficiently (cheaper) and faster than any bank in Indonesia. Lending based on collateral, makes banks forget what a business is about; it slows them down; and confiscating the collateral and selling it will never cover the full cost of the loan. It is slow and inefficient.

“How can we make unsecured loans less risky?” was the question that I asked to several experts in Jakarta. I have made a list of their advice and I’d like to share it with you. Please contribute if you have comments, lessons or suggestions!

FACTORS DRIVING UNSECURED LOAN INTO AREARS (late payments)

• If delinquency (yet another word for late payments) is going to rise it will be consumptive loans that are the first to go into arrears, not productive loans. Consumptive loans are not backed by income/revenues like productive loans are;
• If borrowers get the impression of poor maintenance, laxness, passivity and weak relations between the agent/account officer and the borrower, they will put the account officers to the test.
• The lack of social & peer-pressure will also push up arrears. e.g. a borrower knowing that family members or friends will not hear about his arrears can trigger arrears more easily.
• Economic recession has an impact on micro & SME productive loans, but it is a lot more limited than that suffered by larger companies or consumer lending.

SECURING UNSECURED LOANS

How do you make unsecured loans less risky?

• Focus on productive lending, and try and prevent any opportunity for borrowers to use loans for side-streaming the loan for consumptive uses.
  Check if there is enough liquidity in a company, a high liquidity will increase the chance of “side-streaming”.
  It may also be worth considering to reduce lending volumes or growth before and during Ramadan and Lebaran. Or Christmas and vacations in Christian countries. This is when side-streaming is most common.
• Find measures to identify the integrity of a borrower’s character, i.e. a borrowers willingness to repay the loan.
  . Ask neighbours about the borrowers’ integrity, ask “Have you ever lent money or Would you lend money to your neighbour?”.
  . Ask suppliers if the borrower pays on time.
  . Ask the borrower for a previous loan agreement, then check in the bankbook/statement if the loans were paid on time.
  . A psychometric test of the borrower might be a useful additional indicator, but has not proved to work effectively on its own.
• Alternative credit scoring tools like Lenddo, Friendlyscore, experian, demystdata may work for you. These tools scrape through social media data or caller history of your borrowers, at a cost, but it won’t be a silver bullet.
• Increase social pressure or peer-pressure on a borrower.
  . Include a personal guarantor such as a spouse, brother, uncle, parent, silent business partner/shareholder.
  . Having an agent/ account officer with a personal relationship with the borrower this could be a good and a bad thing. It’s best to avoid these relations as they can foster collusion and fraud;
  . Shaming a borrower on Facebook, may work, but may not be legal (check). And if not legal, try and alter the wording of your posts, like banks do in Indonesian newspapers with their delinquents. Make sure the post text is included in the loan agreement terms so that it acts as a threat, prior to the arrears. An indirect text may work like: “Mr. XYZ needs your help to grow his business, please buy more from him, so he can pay his bills.”
  . Group lending with multiple (m)SMEs could work too. i.e. a repeat loan is only possible if all the borrowers in a group have paid their loans without arrears.
• The undated cheque. A borrower could be required to issue an undated cheque to The lender. If the borrower is late, the undated cheque can be dated and dropped at a bank. If a cheque bounces 2–3 times then the borrower will be listed as uncreditworthy with your local credit scoring system (in Indonesia, the SID database of BI).
• If the borrower is a B2B company, using a purchase order (PO) from a buyer of the borrower or an invoice from the borrower to the buyer can be used only if the buyer is a creditworthy company.
  . Make sure to call the budget holder at the buying company, to verify the authenticity of the invoice or PO.
  . Check the bank book/statement to see if there have been payments in the past from the same buyer, were they paid in full and on time?
  . Check if the Current Assets — Current Liabilities + (PO/invoice) > instalments pending.
  . If the buying company is unknown find out the financial position (online annual report) of the company, can the company pay the PO/invoice?
  . Value the PO/invoice at ± 70% of the face value.
• If a B2B company, call the main buyers to ask about the reliability of the SME as a supplier.
• Try and finance SMEs that supply to a strong purchasing organisation. Have your instalments be paid by the purchasing organisation. This will require a 3-party loan agreement.
• Keep the ownership documents of collateral of the borrower during the period of the loan. Even if this won’t stand up in court, officially it needs to be processed by a notary. Yet it can be a deterrent against arrears.
• Credit insurance can probably cover ± 50% of defaults. Which may just be enough.
• Set limits for segments of borrowers. 10% shops and traders; 10% restaurants & food; 10% agriculture, etc. Balance your portfolio, so if one industry suffers, your portfolio as a whole will not.
• Finally, use the national credit scoring system (FICO, SID, etc) to check the creditworthiness of the borrower.

Thierry Sanders, Jakarta, Indonesia
CEO, mekar.id