Repost: Why fintech lenders in China avoid SMEs

In the fintech circle in Southeast Asia, there is some recent talk about fintech lenders’ bad debt caused by the covid-19 outbreak, from the CNBC Indonesia report on the bad debt of Modalku, to TechinAsia report on fintech platforms in Indonesia tightening credit screening, to The Edge reporting on fintech platforms seeing more restructuring and defaults. 

This reminds us of an old TLD post we did back … pfff… all the way in 2017 titled “Why fintech companies in China avoid SMEs“. We are reposting here:

While all the governments are encouraging P2P to be primarily helping SMEs with credit for growth, the founder of one of China’s largest fintech platforms, has a different perspective.

“I do not do SMEs at all,” he told us at a recent dinner. “They are way too risky in a developing country.”

In fact, he burnt his hand badly in his first few deals of the platform, all with SMEs. “It took us a few years to recover the loss through other deals, and rebuild the confidence of the platform,” he said.

Risks with SME financing

This is not the first time someone cautions about SME financing through (mobile) internet to us. For him, a main challenge is macro economics.

“With individuals, the liability is personal and they need to ensure repayment such that they can continue to borrow,” he said. “SMEs – the good ones – are limited liability and there are so many factors you could not control.”

This is unlike individuals – they will try their best to avoid being bankrupt. And the fact is, in many countries, there is no such thing as natural person bankruptcy.

For example, during 2008 financial crisis, nobody was able to repay their debts – companies went bankrupt, bringing some their creditors with them.

In fact, the flow of financing through non-banking means in the coastal provinces has always been under close monitoring by the state in China. People have been sentenced to jails, or in extreme cases capital punishments were introduced, for disrupting that order.

Also, SMEs in the developing world tend not to keep rigorous financial records. Worse, often the financial data they provide are simply not trustable.

“这你也信” (“You believe in even this???”) has become the catchphrase old guns tell freshly minted finance experts from top universities, when they present a carefully compiled research based on published and revealed data.

The (developing) world, is a much more complex place.

The problem of scaling

That said, factoring or other financing for SMEs have always been there. Many factoring companies went bust, but there are winners in the field.

The (surviving/winning) operators are very experienced in due diligence: from counting the lorries at factory gates to checking inventory in the freezer for food businesses. Some even go the extra length of hiring private investigators, who in turn pay suppliers/customers of target companies to (indirectly) dig out information.

They are also rigorous in controlling the risks – letting go opportunities instead of taking excessive risk.

SME factoring business tend to be small and local in nature – which makes operations easier and risks more controllable. This somehow goes against the very nature of mobile internet business – that is fast scaling and netowrk effect.

What does mobile internet come in place for this? Well, customer acquisition. But essentially what needs to be done offline still needs to be done offline, with costs.

Mobile internet based factoring businesses can scale, but in the same way banks have scaled. Not much more operational leverage unfortunately.

Hard to replicate successes in the US

I have a friend who runs a tech-enabled factoring business in the US, quite successful so far at least from the hundreds of millions of dollars funding that investors haves showered into the business.

His model is very straight forward. First, he only works with companies which already have their financials in the cloud. To qualify for a bridging loan, an SME has to share their financials through an API with the company. The SME will find out on the same day whether they can get the loan, and if they do, the money will be in the account typically the next day.

In fact, decades of regulatory development and the maturity of the fincial system mean that risks are much easier to contain. Taxmen are one of the stakeholders you should thank for this.

Also a crucial enabler of his business is that he does not match, but provides the funds himself – much easier to absorb the losses for non-performing loans.

Alas, it will take a long time for the developing world to reach that stage. A few friends of mine tried to replicate

For the companies which do – they typically do so by telling a good story to investors to get more money than what a traditional (local) factoring company would ever dream of, along with the ability to absorb losses of non performing deals.

In the meantime, it might make more sense for the like of Alibaba and Amazon to provide such financing, especially when SMEs use their fulfilment services – they have the SMEs’ inventory anyway (and real sales data).