Digital lenders eye Indonesian SME financing gap

Flexible new kids on the block see US$60 billion opportunity in banking underbanked

As traditional Indonesian banks, because of their stricter loan requirements, are unwilling to provide the financing desired by small and medium-sized enterprises (SMEs), or even needy but trustworthy individuals, there is a huge finance gap that digital lending platforms with their looser, more flexible requirements are working to fill.

The SME funding gap in Indonesia is estimated to be worth US$60 billion and 77% of the adult population in Southeast Asia’s most populous country are entirely unbanked or underbanked, according to a report by Indonesian B2B fintech platform Fazz, thus presenting the country’s digital financial services sector with considerable opportunities.

Fintech investment in Indonesia reached US$3.2 billion from 2020 to 2022, a 4.6-fold increase compared with funding during 2017 to 2019. And, despite a slight dip in funding value in 2022 due to global macro-economic concerns, Indonesia fintechs, according to a Boston Consulting Group report, still attracted nearly US$1.4 billion in funding, with the majority of it going to digital payment and lending platforms.

For example, Akulaku, an Indonesian digital lending platform that offers personal and installment loans, and other financial services to consumers in Indonesia, the Philippines, Vietnam and Malaysia raised US$320 million in venture capital funding in 2022.

“Digital lenders primarily make loans on an uncollateralized or unsecuritized basis, enabling these products to address a much larger market size,” notes Adrian Li, founder and managing partner of AC Ventures, a leading Southeast Asian venture capital firm. “Because it’s a riskier segment, they can take on a higher cost of capital as they’ll still earn a larger spread.”

“Additionally, these loans tend to have shorter durations, allowing them to recycle and use the capital multiple times to increase the annual internal rate of return of the money involved.”

Capital sources

In the past few years, peer-to-peer (P2P) lending was highly popular, but also came with high risks. However, Indonesian fintechs are not strictly P2P, as their capital sources are primarily institutional. This strategy, Li explains, allows for a scalable source of capital and more stringent underwriting.

“They typically use three primary sources of capital: institutions, banks like HSBC, which might provide loans; equity balance sheets; and special purpose vehicles for high-net-worth individuals and so on,” he says. “This creates a far more scalable pool of capital.”

When banks look to expand their lending capital, they often turn to fintech companies that specialize in lending to the underbanked. Julo, an Indonesia-based digital lending start-up, for example, finances from traditional banks to provide additional capital mainly for individuals, such as financing a university education or helping a small shop owner buy extra inventory. The company has total funding of US$155 million raised over six rounds.

Another example is KoinWorks, a portfolio company of AC Ventures focusing on SME financing, which raised US$43 million in its Series C funding round in early 2022. KoinWorks collaborates with e-commerce platforms to help merchants manage their working capital.

Mitigating risk

However, digital lending also must mitigate risks from various angles. The Indonesian Financial Services Authority (OJK) has the authority to regulate, license and supervise the fintech consumer lending sector.

P2P lending companies, according to regulations, are allowed a maximum foreign ownership of 85%, with at least 15% ownership held by Indonesian entities. Additionally, these providers must have a minimum issued capital of 25 billion rupiahs (US$1.7 million) during establishment that is fully paid and placed in a time deposit, and maintain a minimum equity of 12.5 billion rupiahs at all times.

Despite these regulations, risks to platforms cannot be completely eliminated. Companies need to use accurate data to manage risk effectively and maintain sustainable business margins.

However, the significant number of underbanked individuals highlights the potential societal and consumer advantages in having increased competition and a greater number of providers offering productive capital to both consumers and SMEs. The demand for digital lending is still massive, Li stresses, and the existing players are far from being able to saturate the market.

Li stresses the importance of significance differentiation for digital lending start-ups seeking to raise funds. “For example, as recently as six months ago, we backed a new consumer finance player that is addressing the market differently by helping people understand their credit scores better. They obtain their scores and provide specific instructions on how to improve their credit score, then introduce them to a credit card with a limit so they can improve their credit limit and gain access to credit.”

Without a significant differentiation, he suggests now may not be the most advantageous time for a company to venture into the consumer or SME lending market.

Source : https://www.theasset.com/article/49747/digital-lenders-eye-indonesian-sme-financing-gap