Written by Adrian Li
In billionaire investor Ray Dalio’s classic, it is clear that credit plays a pivotal role in supporting the growth of a country’s economy. In essence, lending enables an increase in spending, leading businesses to invest in greater production. This can lead to longer-term productivity growth and thereby higher income levels in the economy.
Indonesia’s current administration has focused on encouraging investment and consumption to hit ambitious growth targets. Record infrastructure investments have been announced as well as several rate cuts in the past year. However, growth has continued to hover around 5 percent. This could be because demand for credit is low. Another possible explanation is that SMEs and middle-income consumers (a key engine of Indonesia’s growth) have little to no access to credit to actually increase investment or spending.
Severely credit-limited SMEs and middle-income consumers
Indonesia has more than 57 million micro-enterprises, but only around 1 percent of these businesses manage to grow to the size of a sustainable small- or medium-sized enterprise (SME). While the emergence of online and mobile marketplaces such as Tokopedia and Bukalapak have enabled more of these small businesses to grow, the vast majority are still constrained by the unavailability of credit to scale their businesses.
It is estimated that limited access to credit for these companies reduces Indonesia’s GDP by approximately, equating to 14 percent of total GDP. The problem is structural, as most of these businesses are trading companies without property or land to collateralize loans. Hence, traditional banks are also unable to lend to them. Clearly, finding a way for these businesses to have access to credit can unlock huge value.
On the consumer side, we see that household debt comprises 17 percent of GDP compared to neighboring economies Thailand and Malaysia at 70 percent. This indicates that Indonesians in general are under-leveraged compared to their counterparts, which is likely to constrain spending. Even taking credit card adoption in Indonesia as a proxy is striking, as justof the population have credit cards.
Evidently, credit for the wider consumer is limited, which lowers their ability to make not only purchases but also important investments such as homes. But the problem goes even deeper, as many middle-income families are unable to support children to go to university without access to loans. Indonesia’s tertiary education enrollment ratio is onlycompared to developed countries (average at ). Average total tuition expenses also stand at 143 percent of GDP/capita compared to 51 percent in the US. As a result, an estimated 870,000 students do not pursue higher education.
As a largely cash-based economy, most Indonesians lack any reliable source of financial data traditionally used by credit rating institutions. In addition, the major banks in Indonesia earn some of the highest net interest margins around the region, creating little incentive to broaden their reach to subprime borrowers. In this way, many consumers and SMEs remain outside of the credit system, creating a major drag on the growth of the Indonesian economy.
Fintech lending to the rescue
Fintech has been one of the hottest areas to invest in Indonesia for the past 18 months. According to our report, of the 26 deals announced in the last quarter of 2017, one-third were in fintech, raising US$21 million and comprising the second highest industry for investment within technology for the quarter. While historically there has been strong attention on payments, it is only in the past 18 months that investment has focused on the lending space.
How fintech can enable lending to consumers and SMEs
In developed markets with significant banking and credit card penetration, credit agencies take the role of collecting and aggregating consumers’ credit history from multiple institutions. Then whenever a person applies for credit, the lender can check the applicant’s credit history via one of these agencies. The abundance of credit data enables an efficient process for determining the creditworthiness of borrowers.
In Indonesia, with both scant credit card penetration and bank account ownership, even basic data can be hard to obtain. However, the rapid adoption of smartphones have created a device that can provide useful data to assist in ascertaining a person’s creditworthiness in the absence of credit history.
The smartphone itself has become a treasure trove of data that can reveal more insights on a person than your closest friends. From location data, message content, apps, to mobile transactions, all this data is stored and can be accessible to applications that you grant permission to. At scale, correlations between users who are more likely to default on loans and those who are not will appear. Models can be built on common attributes that can guide fintech lending companies on who to make loans to. In China, use of these types of technologies have created billion-dollar lending giants in a relatively short period of time such as Wecash, Qudian, and Dianrong.
Many companies in Indonesia are now also employing smartphone data in order to build credit risk profiles on users using alternative datasets. Indeed, the opportunity to lend to consumers is so great that several verticals have already appeared, such as payday loan financing, consumption financing, small business loans, and education financing. Some examples of companies in this space include Julo and Dana Cita.
While credit can support growth, it can also lead to crises. Even at an individual company level, there are risks. For example, Chinese company Ezubao reportedly raised over US$9 billion in funding from over 900,000 investors before toppling and being unveiled as a Ponzi scheme.
For this reason, it is right for the Indonesia Financial Service Authority (Otoritas Jasa Keuangan or OJK) to lay the ground work for regulatory oversight in this industry, especially in a hot market attracting VC funding where entrepreneurs are driven to achieve growth at all costs. Such regulation should be done openly and transparently, allowing for fair competition and guidelines that protect investors and consumers. Correctly implemented, fintech will have a massive impact in supporting Indonesia’s growth and open up access to credit for the broader population.
Financial infrastructure and banking institutions around the world have played a critical role in the advancement of economies. Efficient mechanisms of payment and effective banking systems are required to enable economies to transact and grow through the recycling of capital through savings and lending. Regional fragmentation of the banking sector results in many subscale banks, while the top 10 pull in huge profits, creating little incentive to reach out to riskier consumers or companies. This results in the perfect opportunity for fintech to rise and step up to solve a gigantic problem.
Featured Image Copyright: Bady qb