Within Southeast Asia, the financial services industry holds a tremendous potential that could be unleashed if fundamental underlying challenges are addressed.
Out of a population of 570 million in Southeast Asia, more than 70 per cent of the adults are “underbanked” or “unbanked” and have limited access to financial services. In addition, millions of micro, small and medium-sized enterprises (MSME) face large funding gaps.
According to Bloomberg more than one in three MSMEs expect their need for financing to increase in the future. The funds will likely be used to invest in new technologies, as solutions used on a daily basis evolve; and business opportunities as they arise.
MSMEs are seeking sources of funding that are available ‘on-demand’, enabling them to respond to opportunities and threats that quickly arise.
Traditional funding options are failing to meet the demand and hence MSMEs are looking for ‘alternative’ funding options that can meet their needs.
According to Bloomberg, based on the findings that businesses are increasingly adopting novel digital tools and platforms, a logical next step for MSME could be to seek out complementary, non-traditional microfinancing solutions when it comes to funding.
The importance of MSME and the funding gap
MSME plays an important role in the Asian economy. Although estimates vary, several sources suggest that MSME account for over 95 per cent of all firms, contributes to 50–70 per cent of employment, and constitutes 30–60 per cent of various countries’ gross domestic product.
The MSME loan to GDP ratio remains low in most ASEAN nations, with figures ranging from three to 34 per cent. The situation is particularly severe in the Philippines and Indonesia, both of which have ratios in single digits.
Also Read: How fintech can help reach the unbanked and underbanked in Southeast Asia
Malaysia and Singapore fare better with 55 per cent and 36 per cent respectively, while Thailand leads the way with 105 per cent of the GDP ratio in SME loans.
According to studies, the vast majority of MSMEs in Southeast Asia currently fund their businesses with their own savings (90 per cent), or rely on family or friends (40 per cent).
Why is there a funding gap?
A lot of MSMEs have little to no resources and some lack even the most basic business skills, such as how to add a markup to products or filling out business loan applications.
Approximately 80 per cent of MSME say they want to borrow but lack access to affordable credit.
The top four reasons why MSME are struggling to get a loan:
- High interest rates
- Troublesome process
- Don’t know where to go
- Application rejected
And so MSME remains a largely underbanked segment in most markets within Southeast Asia.
Why are traditional banks not filling this gap?
- The costs to provide a US$5-10,000 loan are high so banks won’t find it worth the effort
- A general lack of data on the financials of the MSME for the banks to give a proper credit rating
- Banks lack the digital infrastructure to analyse and disperse smaller loans
- There’s a general risk-averse perspective on unsecured loans also because other bank products might be more profitable and less risky
And so technology-enabled business models that offer a more effective way to serve MSME are leading the way and are creating new market opportunities.
Customer gatekeepers
Established players risk (partly) losing the MSME segment to new (technology) players that can use nontraditional data sources to create access and supplement underwriting, and offer a broader suite of products and new delivery models (such as offline-to-online platforms) to address the needs of MSME.
New players that can serve as a customer gatekeeper will have an advantage in the battle for MSME. Innovators that offer a vertically integrated solution to meet different MSME merchants’ needs will gain marketshare.
Offline-to-Online
Fully digitalising the process immediately is not realistic and in the next five years we will need hybrid solutions where data is processed automatically while keeping in-person interactions to create trust and provide guidance.
Underbanked MSME in Southeast Asia generally still rely on the physical presence of a bank to handle their finances. Some innovators are closely working together with banks to utilise their existing physical retail presence.
Others have integrated with point-of-sale systems or accountancy software and leverage existing trusted business relationships.
However, one can expect that the offline element will almost completely disappear in due time as has already happened in more advanced markets like Singapore, several countries in Europe and the US.
Which countries and who is disrupting?
Southeast Asia is a huge market, but it is an extremely fragmented region. There are 11 countries, each differs significantly in terms of regulation, economy, infrastructure, and culture.
This space has been heating up and a range of players have launched over the past few years and are trying to get a piece of the pie. Some working closely together with banks, others launched P2P lending platforms and some players have even obtained a license to lend directly from their balance sheet.
Some examples:
Funding Societies (Singapore + Indonesia): Kelvin Teo, co-founder
“Even if we focus on bigger markets such as Indonesia or its capital Jakarta, there are nuances working with people who come from the 17,000 different islands in Indonesia. Each time we enter a new country, we need to rebuild the business from scratch. And for most parts of Southeast Asia, regulations are still unclear, credit and fraud risks are high, and the legal framework does not provide meaningful recourse for lenders. Hence we paid quite a bit of ‘school fees’ in terms of time and resources to build and scale.”
Grab Finance
When you start a small business, you’ve got big dreams. And GrabFinance is here to help. We’re committed to empowering SMEs across Southeast Asia with funding, tools, and insights so they can reach their goals, no matter what they are.
Offline-to-Online problem remains
Few innovators seem to have tackled the offline-to-online problem in a scalable manner through and so the real customer (MSME) gatekeepers still have to emerge.
This is likely due to the fact that these players have mainly focussed on their internal operations and credit algorithms to keep default rates low, rather than purely focussing on building new channels to grow loan origination.
Next to this, there’s a large group of ‘advanced’ MSME, such as e-commerce businesses (vs. brick-and-mortar), that can be accessed without having to solve the fundamental offline-to-online problem.
Lending is the biggest opportunity
By 2025, digital financial services are expected to generate revenues of about US$38 billion and account for 11 per cent of the total financial services industry.
Digital lending is expected to grow 33 per cent annually to reach US$18 billion by 2025, replacing digital payments as the largest contributor to the digital financial services revenue pool.
Google and Temasek have predicted that SEA’s loan book will increase two-to threefold reaching $110 billion by 2025.
Regulations needed to reach full potential
Attaining the full revenue potential requires several factors to fall into place, including continued investment and incentives to stimulate innovation and user adoption. But the biggest uptick will come from supportive regulations and government policies.
ADBI in 2019: While several legal and regulatory challenges remain and the resilience of these new funding models have not yet been tested in a downturn, new technologies have already started to transform SME financing.
We can conclude that digital lending services are a large opportunity in Southeast Asia. Multiple players have entered the market over the past few years and are trying to ‘crack’ the problem.
It seems that the complete recipe for success is still to be invented but a winner in the market likely looks like this:
A strong (offline-to-online) customer gatekeeper with a scalable business model that is supported by the government and has a vertical integration with third-parties to collect data and disperse loans.
Such a winner might come from an unexpected corner such as a point-of-sale company or a provider of accountancy software that has an established relationship with MSME.
–
Register for upcoming webinar: From zero to 100: How to grow your startup workforce
Register for Meet the VC: Genesis Ventures
Editor’s note: e27 aims to foster thought leadership by publishing contributions from the community. Become a thought leader in the community and share your opinions or ideas and earn a byline by submitting a post.
Join our e27 Telegram group, or like the e27 Facebook page
The post Why digital lending services for MSMEs are the next big thing in SEA? appeared first on e27.