Understanding the Lending Models of Indonesian Fintech Startups

Written by Alvin Cahyadi

Originally published here by Bisnis.com.

Coming from one of the large global retail banks and having learned about risk management and consumer products in particular, it has been exciting to see the growth of the fintech sector. Approximately a month ago, our Managing Partner, Adrian Li, wrote about how fintech lending can boost Indonesia’s lackluster growth. After reading this, my team and I thought it might be useful to elaborate on this and illustrate how we are seeing the various ways fintech lending players in Indonesia are going after this space.

Let’s first recall the opportunity that fintech lending presents. Indonesia’s finance authority (OJK) estimated approximately US$74BN in unmet financing needs in 2016 due to the lack of credit data of loan applicants – a critical gap that is largely served by unlicensed offline lenders (aka loan sharks). Further to this and as we have seen, Indonesia’s sizeable market opportunity for alternative lending has generated a myriad of financial technology companies in the past several years. Indonesia’s Fintech Association’s latest data indicates 134 fintech companies have been fully registered as per April 2018, more than doubled from only 55 in 2016.

 The various existing fintech lending players can be categorized based on i) the recipient and ii) purpose of the loans as well as iii) the source of lending capital. Below is table of some of financial technology startups in Indonesia categorized according to the financial product they offer based on our study.

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Fintech startups can either lend to individuals or businesses. It’s important to note that being a lender for individuals does not prevent the startups to lend to SMEs, and vice versa. Generally, the key differentiating factor is the product offered by the startups. For the ones targeting individual borrowers, the products commonly offered as depicted above, include special purpose loans (mortgages, car financing and education loans), payday short term loans, pawnshop services, multi-purpose consumptive loans and payroll financing loans. On the other side, those who lend to businesses (SMEs) offer SME invoice financing, SME long term financing and equity crowdfunding. Startups offering all of the above will take the inherent risk of each type of loan and generally, manage this risk by balancing interest rates against their projected non-performing loans. 

Taking it one step further, we can also categorize based on where the startup sources their lending capital.  While there are essentially 3 models based on sources for lending capital, startups also can combine multiple models. Below are the variety of models we can identify today.

1. Crowd-lending or P2P Model:

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P2P lending model is a model where the fintech startup acts as a connector between borrowers and lenders- essentially becoming a marketplace for loans service. On top of being a connector, the fintech company also runs a risk management platform to assess credit worthiness for the borrowers and to assign interest rates to borrowers’ financing request. The lenders can see the risk level for a specific loan request and make a decision based on that. In the P2P lending model, the lenders are usually individuals who have access to money and the borrowers could be an individual who needs consumptive loans or a SMEs that needs additional working capital. Usually the platform will pool money from multiple lenders to fully satisfy the funding requirements. Due to the platform only mediating the borrowing process, default risk is being carried by the lenders. Fintech companies using this model generates revenue by charging service fees which is usually deducted from the loan disbursed to the borrowers. The interest payments from the borrowers would all be given to the individual lenders for the project. Examples of startups with this model are Modalku, Koinworks, and Investree.

2. Balance Sheet Model

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What is the definition of Balance Sheet model?

The financial technology startups that use this model essentially use their equity financing to fund loans or take on lending capital from other financial institutions. The fintech companies assess the risk and assign interest rate for the financing needs and then disburse loans from their own pocket (balance sheet) for the projects that fit their risk criteria. Naturally, since the fintech uses its own money to disburse the loan, the default risk as well as the interest income are being given to the fintech company. An Example of a startup that works with this model is UangTeman.

3. Institution-Backed Lending:

Startup with this model partners with banks as their funding source. In general, the partnership formed could be one of the 2 models below:

I. Pure Institution-Backed Model:

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Pure Institution-backed model means the startups directly disburse from third-party institutions’ pocket to make loans, thus the lender is basically the institutions. In this model, the fintech startups act as a lead generator of credit worthy borrowers whereby only the borrowers that pass the fintech startups’ risk assessment would be sent to the financial institution. Since the loan is generated using the institutions’ money, the default risk is assumed by the financial institutions as well. In this model, the fintech company makes revenue from commission fees out of the loan disbursed.

II. Hybrid Model:

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In the hybrid model, the startups borrow money from financial institution to make loans and hence the startups incur cost of funds for each loan disbursed. In this model, different from pure institution-backed model, the fintech companies are still being the lenders and therefore assuming the loan default risk. The startups in this model generates revenue from both origination fees and interest income. An example of a financial technology startup that use this model is Julo.

Indonesia’s fintech lending landscape is heating up, and we are excited to see the impact of it in the near future. Nevertheless, it is important to note that fintech lending cannot grow alone if it is to maximize its potential in Indonesia. Strong payments and remittance systems are mandatory to ensure the lending facilities are able to capture the entire population across the archipelago. Fortunately, we have seen similar patterns of development in these sectors which gives us a strong reason to be hopeful for fintech disruption.

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