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Mitigating risks in digital lending

An investor man standing on the right-side cliff tries to save his money flowing from a briefcase that is on a left-side cliff

Mitigating Risks In Digital Lending:
What Investors need to know

Digital lending has developed as an increasingly popular alternative to traditional lending methods in recent years. Investors are drawn towards the potential high returns and increase access to data, enabling them to provide capital to a wider array of borrowers.

Nevertheless, due to the rapid pace of change and innovation, investors often face an evolving landscape of risks that require effective risk mitigation strategies to match the speed of quick cross-border transactions. This article aims to explore the primary risks directly impacting digital lending and offer effective risk management solutions for investors.

An investor man standing on the right-side cliff tries to save his money flowing from a briefcase that is on a left-side cliff

Risks in digital lending

Anti-money laundering and countering terrorist financing

Anti-money laundering (AML) and countering terrorist financing (CTF) are important regulatory requirements that apply to all financial service providers, including digital lenders. AML policies are intended to stop using financial services for money laundering, while CTF measures aim to restrict the financing of terrorist activities.

Due to the large volume of online transactions and innovative technology like blockchain and cryptocurrencies, digital lending can be particularly vulnerable to AML/CTF risks. These innovative technologies may be misused by criminals and terrorists to conceal their identities and the source of their finances.

To mitigate these risks, investors should allocate their funds to digital lending companies with solid AML/CTF compliance programs. These programs usually entail conducting additional due diligence on borrowers, constantly watching out for suspicious transactional activity, and reporting it to the appropriate regulatory authorities. To share information and prevent illegal activities, digital lenders may also need to work with other financial services providers and law enforcement organizations. Failing to abide by AML/CTF standards may incur serious legal and financial penalties and reputation damage that may jeopardize the digital lending business’ future.

Consumer and merchant risk

In digital lending, the terms “consumer risk” and “merchant risk” signify the likelihood that a borrower (either a consumer or SME) would fail to make payments on time or will default on the loan, causing the lender to suffer a monetary loss.

Digital lending platforms rely on algorithms and data analytics to evaluate the creditworthiness of the borrowers by using alternative data sources (like social media activity or online purchasing behavior) apart from traditional credit history. This approach expands access to credit for borrowers who lack long credit histories, but it also elevates the risk of lending to individuals or companies that are not able to pay back the loan. Moreover, given the ease with which digital footprints can be fabricated, lending institutions must exercise caution to avoid being deceived by false data.

Given the risk inherent in the digital lending landscape, investors may suffer significant financial losses, by failing to receive loan repayments if a platform does not properly manage its capital. To avoid such scenarios, investors should consider digital lending companies with robust risk-management procedures incorporating advanced underwriting models that reliably assess creditworthiness, continuous borrower performance monitoring, and adequate provision of capital to absorb losses. Further, regulatory control and transparency in lending procedures can assist in guaranteeing that borrowers are not the targets of unfair or predatory lending practices that could put them at risk.

Cybersecurity risk

The risk of cybersecurity threats, such as fraudulent transactions, extortion, denial of service attacks, and credit card fraud, has increased in the FinTech sector due to the popularity of electronic wallet solutions. Such cyberattacks have the potential to seriously damage crucial economic infrastructures and jeopardize the stability of the whole financial sector by compromising sensitive information, purposefully harming the hardware, and disrupting services.

To minimize the cybersecurity risks in digital lending, it is crucial to remain vigilant of technology defects. This includes identifying potential security vulnerabilities in hardware, software, or network infrastructure.

Digital lending businesses should conduct regular risk assessments and penetration tests to spot any security weaknesses and address them properly. In addition, it is important to implement robust security protocols like encryption, multi-factor authentication, access controls and regular security updates. Training employees on cybersecurity risks through awareness programs is also necessary.

Fraud risk

Fraud risk in digital lending refers to the possibility of cyber criminals engaging in fraudulent activities like false documentation, identity theft, or loan stacking, for obtaining funding from digital lending firms. The usage of the internet has made it simpler for fraudsters to conduct their activities as they can impersonate other parties or create unreal identities more easily. If these fraudulent actions go unnoticed, digital lending companies may suffer considerable financial losses or reputational harm.

To reduce the risk of fraud, investors should finance digital lending companies that have robust fraud prevention measures in place, including stringent identity verification and authentication procedures, advanced fraud detection tools, and effective transaction monitoring systems.

Additionally, investors should also consider companies that maintain strict control over their internal systems and conduct regular risk assessments to identify and address any potential fraud concerns. Collaboration with regulatory bodies and law enforcement organizations is likewise important for exchanging information and coordinating initiatives to prevent fraud.

Market risk

Digital lending and the financial system are exposed to market risk because of their sensitivity to news and industry updates. This risk can be particularly observed whenever the market experiences sharp increases in interest rates or unanticipated economic shocks that cause extreme market reactions. Such situations might lead to serious solvency and liquidity problems, as observed in the case of the failure of Silicon Valley Bank earlier this year.

Market fluctuations can create excessive volatility, contagion, and pro-cyclicality, that may disrupt financial services. In these situations, customer support teams should produce ad-hoc solutions since contingency planning might no longer be able to provide adequate reaction.

Investors can mitigate the impact of unforeseen market events by investing in digital lending companies that implement robust risk management measures such as stress-testing models and contingency plans.

Additionally, it is crucial to ensure that these companies maintain sufficient levels of capital and liquidity to meet expected cashflow requirements and manage potential losses effectively. By following these guidelines, investors can minimize the risks associated with market volatility and make more informed investment decisions. To get more insights, read this article comparing traditional assets and digital lending.

Operational risk

Digital lending companies encounter operational risk in various cases such as when their established procedures and operational norms cannot keep up with the pace of work, unpredictable market conditions, and sudden unexpected changes.

Unlike traditional financial institutions that have time in their favor, digital lending companies operate at an incredibly fast pace. They are more exposed to real-time operations management, where 99% of the most crucial errors happen. The reliance on technology and automated processes increases the chances of facing operational failures from system malfunctions or cyber-attacks as well.

To mitigate operational risk, it is recommended that investors consider digital lending companies that have robust operational risk management procedures in place. These measures should include maintaining a strong control environment, providing regular training to staff, and implementing effective oversight and compliance monitoring.

Additionally, it is important for digital lending firms to adhere to regulatory requirements to minimize the risk of operational failures. By partnering with companies that prioritize operational risk management, investors can minimize the potential impact of operational issues on their investments.

Regulatory risk

Regarding laws and compliance, the whole FinTech industry places a strong emphasis on risk. Authorities must ensure that FinTech companies accurately assess risk and put risk-reduction measures in place.

However, regulative scope in many nations lags the pace of technological advancement. This suggests that for digital lending companies, regulatory norms are changing quickly, making it difficult to standardize compliance methods. While some FinTech sectors are not as strictly regulated as conventional financial institutions, regulations like PSD2 and GDPR set standards for data protection and system security processes, which have an impact on the entire European FinTech industry. Digital lending companies are frequently subject to additional regulations imposed by national agencies, such as the CFTC and SEC in the United States, FCA in the UK, BaFin in Germany, and ACPR & AMF in France.

If these requirements are not carefully followed, businesses run the risk of being found in noncompliance, suffering penalties, and losing their reputation in the market. To avoid this, investors and digital lending companies should stay informed about regulatory changes and understand how these changes might impact their business. They can do so by participating in different industry events and by monitoring relevant published papers or news. Creating and maintaining strong relationships with regulators by seeking their guidance is also important. FinTech companies should also execute regular audits to guarantee compliance with regulations and detect spaces for improvement. for improvement.

What investors need to know

As an investor, you can take several measures to mitigate the risks that come with investing in digital lending institutions. To start with, before investing your capital in a company, you should make sure you have properly understood the business model of the company, its financial performance, market position, its cybersecurity measures, and regulatory compliance. Without doing due diligence, investors will be more prone to facing the above-mentioned risks in the future.

Diversification of the portfolio is another fundamental principle in any investment strategy, that leads to lower risk exposure and optimized returns. By distributing your capital to multiple companies with varying risk profiles, within the digital lending sector, you can reduce your exposure to any specific company or market segment. In this way, you can protect yourself from experiencing significant losses from adverse market circumstances.

It is critical to take a proactive approach to investment management and to monitor your investment portfolio regularly. Particularly in the dynamic FinTech industry, in which economic trends and events can affect the performance of individual companies and the broader financial environment. By being updated with the latest news, you will make more informed future decisions. To gain important insights into your investment portfolio’s potential, you will want to track the performance of the firms in which you decided to invest by calculating key financial performance metrics and indicators.

Last but not the least, if you are looking to invest in digital lending companies that you believe have the premises to transform the industry in the future, you will need to seek professional advice provided by third parties that are not directly affiliated with them. They can help you to create a better understanding of the company’s business model, growth prospects, and competitive landscape.

By leveraging the expertise of these professionals, you can gain a better understanding of the company’s financial performance, market trends, and regulatory challenges. Having access to this information empowers you to make better-informed choices concerning your investment portfolios. Apart from that, seeking advice from independent professionals can offer an unbiased perspective of the potential risks and returns of a specific investment. By adopting this approach, you can avoid any conflict of interest that can emerge while seeking counsel from individuals that are directly affiliated with the digital lending platforms that you want to invest in.

Additional readings:

Bank, W. (2021). Consumer Risks in Fintech – New Manifestations of Consumer Risks and Emerging Regulatory Approaches. Open Knowledge Repository. https://openknowledge.worldbank.org/handle/10986/35699?show=full

 

Digital lending: Regulatory trends. Retail Banker International. (2022, March). https://www.retailbankerinternational.com/comment/digital-lending-regulatory-trends/

Pascual, A. G., & Natalucci, F. (2022, April 13). Fast-moving fintech poses challenge for Regulators – IMF. https://www.imf.org/en/Blogs/Articles/2022/04/13/blog041322-sm2022-gfsr-ch3

About Exaloan

Exaloan is the leading technology provider for institutional investments in digital loans. Its mission is to close the global funding gap for individuals, entrepreneurs and SMEs by connecting institutional capital with digital lending platforms. By operating a global B2B marketplace, the company opens up digital lending as a new asset class.. As an independent agent and validator, Exaloan provides a fully digital investment infrastructure with a standardized risk assessment of each single loan through its Loansweeper™ platform. At the core of its business, Exaloan uses big data and predictive analytics to generate an independent real time credit analysis as well as dedicated insights and reporting for institutional investors, banks, and lending platform partners. Insights cover topics such as sustainability reporting, advanced portfolio analytics, and market research.

Behind Exaloan stands an experienced team with extensive know-how in the areas of quantitative portfolio management, capital markets, machine learning, and software development.

 

If you want to find out more, reach out to us.

We look forward to working with you!

Get in touch!

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How can FinTech lending help SMEs access funding efficiently?

A picture showing two SME borrowers using FinTech lending platform to obtain funding. The man is standing while the woman is sitting with her phone.

Review and reflection:
How can FinTech lending help SMEs access funding efficiently?

A picture showing two SME borrowers using FinTech lending platform to obtain funding. The man is standing while the woman is sitting with her phone.

Small and medium-sized enterprises (SMEs) play a vital role in driving job creation and innovation, making them a critical component of a thriving economy. Nevertheless, these entities frequently encounter challenges in obtaining funding from traditional lenders due to demanding requirements such as collateral, extensive documentation, and lengthy approval processes. Consequently, a funding gap for SMEs has emerged, posing a significant obstacle to their growth and development. The Bank of England (2019) has reported that approximately 25% of small businesses seeking loans from banks are denied, resulting in a significant financing gap of £22 billion for UK SMEs. 

The global emergence of FinTech companies has brought about a notable positive transformation in the finance industry in the past decade. These companies use cutting-edge technology to offer tailored financial products and services that meet clients’ diverse needs. They have embodied a new range of products made specifically for the needs of SMEs. For instance, P2P (peer-to-peer) lending, invoice financing, online supply chain financing, online trade financing, and e-commerce financing. 

These alternative funding sources are particularly beneficial for Startups and businesses with limited credit history or collateral, who may not meet the eligibility criteria for traditional bank loans. Additionally, banks, as traditional lending institutions, are susceptible to different macroeconomic events, as evidenced by the recent collapse of Silicon Valley Bank (SVB), which marked the largest bank failure since the Global Financial Crisis. With assets exceeding $200 billion, SVB was a leading institution in the venture capital industry, primarily focused on Tech Startups. Its collapse has had adverse implications for SMEs that had secured funding through SVB, exposing them to external shocks and potentially jeopardizing their operations. 

According to a paper published by ECB (2022), SMEs are more likely to turn to FinTech lending when they have relationships with banks that possess less stable funding sources, lower asset liquidity, and lower capital ratios. This suggests that one of the reasons for the shift towards FinTech is to mitigate exposure to banks that may not have the capacity to absorb shocks and are more prone to reducing lending activities during liquidity crises. These findings highlight the importance of the quality and resilience of banks in the decision to utilize FinTech lending platforms.  

By obtaining loans from FinTech companies, SMEs can diversify their lending relationships and reduce their dependence on a single bank, thereby enhancing their financial stability. The findings indicate that the SMEs seeking access to FinTech platforms are motivated to decrease their vulnerability to potential shocks to the banking system. Such shocks can restrict their access to financing, consequently impeding their growth prospects. Notably, the lending sector has experienced significant changes due to FinTech innovations, particularly for SMEs (Feyen et al., 2021).  

Five main influences of FinTech lending on SMEs

Increased Access to Financing

According to a report by the World Bank, approximately 70% of SMEs in developing economies lack access to credit. FinTech lending has helped bridge this financing gap by providing SMEs with access to credit that was previously unavailable to them. These credit lending platforms use alternative data sources and advanced analytics to evaluate creditworthiness. This way, they make it easier for SMEs to access the funds they need in a way that traditional lenders would have deemed too risky. Based on a study made by Nesta (2013), 33% of SME borrowers using marketplace lending platforms believed they would not have been able to obtain funding from other sources.  

Decreased Borrowing Expenses

FinTech lenders have disrupted the lending market by offering reduced interest rates and fees in comparison to traditional lending institutions. They do so by applying Data Analytics and Artificial Intelligence to evaluate credit risks and determine loan eligibility, which can reduce borrowing costs for SMEs in several ways. Firstly, data-driven decisions can help lenders make more accurate credit assessments of SMEs, considering data points such as cash flows, payment history, and credit scores. This is made to ensure that only creditworthy SMEs receive loans, thus reducing the risk of default. Secondly, lenders can provide more personalized lending solutions by analyzing data on SMEs’ specific needs and characteristics. This assists SMEs in achieving their objectives without getting excessive debt, reducing again the likelihood of default. Through the usage of Data Analytics, lenders can develop early warning systems to detect potential signs of financial distress among SMEs, allowing them to take proactive measures to help SMEs avoid default. Also, by using Data Analytics and Artificial Intelligence, the lending process is more automated, from credit assessment to loan disbursal. This reduces the time and resources required to process loans, resulting in lower borrowing expenses for SMEs. 

Efficiency and Effectiveness

Traditional lending processes can be time-consuming, with borrowers having to wait for weeks or even months to receive a loan. FinTech lenders have streamlined the lending process, making it faster and more efficient. According to a study by Harvard Business Review (2020), FinTech lenders can process loan applications in as little as 24 hours. This speed is particularly beneficial for SMEs that require financing urgently to take advantage of business opportunities or address cash flow challenges.  

Increased Competition

The rise of FinTech lending has not only made it easier for SMEs to obtain the financing they need to grow and expand their businesses, but it has also increased competition among lenders. Traditional lenders have been forced to adapt to these changing conditions and innovate their own lending products to remain competitive in the market, thus offering a wider range of opportunities and better conditions for SMEs seeking financing. 

Improved Customer Experience

Another benefit SMEs have from FinTech lending is the improved customer experience. Most FinTech lending allows SME borrowers to apply for a loan online. With a user-friendly interface offered by those digital lending platforms, SME borrowers can track their applications more easily, and the entire process is relatively transparent. It is safe to say that digital lending helps SMEs save time and energy to focus on their businesses.  

Statistical Data

According to a report published by Allied Market Research (2021), the worldwide market for FinTech lending had a value of $449.89 billion in 2020 and is projected to increase by 27.4% (CAGR) from 2021 to 2030 to reach $4,957.16 billion. In the past year, 22% of European startups in the financial and technology sectors increased a sum of $22.2 billion, making FinTech the most well-funded industry in 2022 (Pun, 2023). As the FinTech lending industry continues to grow and evolve, SMEs can expect to benefit from even more innovative products and services that help them achieve their business goals.

A survey conducted by EY in 2022 showed that a significant percentage of SMEs are interested in accessing financing quicker. Specifically, 66% of SMEs expressed interest in faster access to funding, with 55% wanting to secure financing within one week and 31% seeking to do so within three days. While banks remain the preferred source of funding for the majority of SMEs (63%), the popularity of FinTech lending institutions has grown considerably (56%) since the onset of the COVID-19 pandemic. In light of these developments, SMEs are increasingly seeking digitally driven, simplified, and faster funding solutions. Consequently, if banks are unable to provide these services, more and more SMEs will turn to FinTech lending companies.

Concluding Remarks

In the future, it is likely that FinTech lending will continue to play an increasingly important role in providing financing solutions for SMEs, as FinTech lenders continue to refine their offerings and cater to the needs of this growing market. This could consist of solutions such as revenue-based financing, which enables SMEs to repay loans based on a percentage of their expected future revenues, or invoice factoring, which allows companies to receive an advance on their upcoming invoices. 

Finally, as the global economy becomes increasingly digital, FinTech lending may end up becoming the main source of funding for SMEs across many nations. By utilizing the most recent technological developments, digital lenders can reach a broader range of customers than traditional lenders, especially those in emerging markets with limited credit histories. This could help drive economic growth and create new opportunities for entrepreneurs and businesspeople worldwide. 

About Exaloan

Exaloan is the leading technology provider for institutional investments in digital loans. Its mission is to close the global funding gap for individuals, entrepreneurs and SMEs by connecting institutional capital with digital lending platforms. By operating a global B2B marketplace, the company opens up digital lending as a new asset class.. As an independent agent and validator, Exaloan provides a fully digital investment infrastructure with a standardized risk assessment of each single loan through its Loansweeper™ platform. At the core of its business, Exaloan uses big data and predictive analytics to generate an independent real time credit analysis as well as dedicated insights and reporting for institutional investors, banks, and lending platform partners. Insights cover topics such as sustainability reporting, advanced portfolio analytics, and market research.

Behind Exaloan stands an experienced team with extensive know-how in the areas of quantitative portfolio management, capital markets, machine learning, and software development.

 

If you want to find out more, reach out to us.

We look forward to working with you!

Get in touch!

Share it with your friends!

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Investing in Digital Lending Market 2023

Cover image for Exaloan blog investing in digital lending online loan alternative lending market 2023

Investing in the Digital Lending Market 2023

Cover image for Exaloan blog investing in digital lending online loan alternative lending market 2023

Img1. Investing in Digital Lending Market 2023 – Exaloan AG

Jump to:
  1. What is digital lending?
  2. 2023 FinTech Trend
  3. Is it a good idea to invest in the digital lending market in 2023?

What is digital lending?

Digital lending/peer-to-peer (P2P) lending/online lending is a remote and automated process of borrowing and lending money via online platforms. These platforms connect borrowers and lenders directly, bypassing traditional financial intermediaries like banks.

The prevalence of digital lending

The popularity of digital lending has been growing over the last decade, with the rise of FinTech and digital transformation in the financial services industry.

In the early 2010s, a number of online P2P lending platforms emerged, offering individual investors the opportunity to lend money directly to borrowers. Since the convenience for both lender and borrower, the push from the global financial crisis, and the good returns to investors, there were more and more digital lending platforms showing up in the market.

In the following years, traditional financial institutions, such as banks and credit unions, began to embrace digital lending, and the industry continued to grow and evolve. According to EY Global Banking Outlook 2022, many SMEs turn to using digital lending services for a simpler and faster lending process and better customer experience. Traditional financial institutions have realized that digital lending is an opportunity not to be missed for competitive differentiation.

Today, digital lending is a well-established and rapidly growing sector of the FinTech industry, with a wide range of products and services available to borrowers, lenders, and investors.

Compared with traditional lending, digital lending has the following advantages:

  • Convenience:

    Digital lending platforms are typically more convenient than traditional lending institutions. It allows borrowers to apply for loans and manage their accounts online or through a mobile app. Borrowers don’t have to repeatedly visit a brick-and-mortar location during the lending process.

  • Speed and cost-efficiency:

    Digital lending platforms often offer faster loan approval times than traditional lending institutions, which usually will take weeks or even months to process a loan application.

    Meanwhile, it also helps lenders save money by reducing overhead costs. Traditional loan processing requires much human labor to handle the paperwork and other tasks, and lenders must pay those costs. Lenders only need to hire limited staff to manage the entire process of online lending.

  • Increased accessibility and a larger potential market:

    Online lending allows lenders to reach customers who might not otherwise consider them as potential borrowers, including people with bad credit, those living outside major metropolitan areas, and even people who are self-employed.

  • Transparency and easy to be analyzed:

    For borrowers, digital lending platforms generally provide more transparency in terms of fees, interest rates, and loan terms, which can help borrowers make informed decisions about their financing options.

    From the investors’ perspective, online lending simplifies loan disbursement and creates a repository of application, underwriting, and funding data. When the power of analytics is added to the mix, investors will get considerably more efficient risk management and better portfolio performance.

The digital lending industry is a global market. Digital lending service is available in many countries around the world.

 

As of 2022, the top 5 most significant markets for digital lending are the US, China, the UK, India, and Europe. Large and mature financial services, a supportive regulatory environment, and a high level of technology adoption are necessary conditions for allowing digital lending to emerge and grow within a market.

Digital lending in 2023 and other sectors in the FinTech industry

With the surging tides of central bank stimulus, globalization, and pandemic-related phenomena that had maintained widespread expansion across the FinTech sector, it is facing a variety of particular difficulties. As 2023 approaches, topics relating with money, compliance, regulatory requirements, and managing the rapidly evolving digital environment will be very important. In this article, we will talk about FinTech trends for 2023:

  • Digital lending will continue to grow:

    Digital loans have been greatly influenced by FinTech startups. By leveraging on consumers’ desire for a frictionless experience while obtaining instant funds, FinTechs will emerge as a strong pillar for supporting SMEs.

    Lenders in the FinTech sector will be crucial in repairing the economy. A new path in the financial industry is anticipated to be made possible by digital lending.

  • Mobile payments will become ubiquitous:

    By 2023, mobile payment options will be available at majority point of sale. From vending machines to gas stations, retailers will accept cashless transactions as standard practice.

    Even though there is still much to be developed, the path is evident. The future of payments, payment processing, and payment gateways will be represented by mobile payment technologies.

  • Blockchain will continue to grow:

    While there’s no doubt that blockchain has been hyped as the future of finance, it’s also true that its potential is being slowly realized now. From the rise of bitcoin to the emergence of new applications such as smart contracts, blockchain will continue to grow for becoming an integral part of our lives.

Is it a good idea to invest in the digital lending market in 2023?

Yes, investing in digital lending is a good idea. And here are the reasons:

The digital lending market is expected to continue (rapidly) growing in the future, driven by factors such as the increasing use of mobile devices, advancements in artificial intelligence and big data, and a growing demand for alternative lending options. According to Statista’s forecast, the digital lending market size will reach 401.7 billion US $ by 2025.

Moreover, recession will BOOST the development of digital lending.

 

In times of recession, traditional lending sources such as banks may become more cautious about lending, making it harder for borrowers (especially SMEs) to secure loans. This could lead to increased demand for alternative lending options, such as digital lending platforms.

 

During a recession, digital lending platforms may also see an increase in borrowers who have been negatively impacted by the economic downturn, such as small business owners struggling to stay afloat. As a result, these platforms may have more opportunities to originate loans to borrowers who may not qualify for loans from traditional financial institutions.

 

Additionally, in a recession, traditional financial institutions may tighten their lending standards and may not be able to lend to certain borrowers who would have been approved before. This situation forces borrowers to find alternative lending sources.

 

However, we need to point out that the recession can also have a negative impact on the digital lending market, such as an increase in defaults and delinquencies among borrowers. This can lead to a loss of confidence among investors and lenders, which could lead to a decrease in loan origination and higher borrowing costs. To stop the rot, investors should be cautious and evaluate the investment in many different ways, such as credit risk, lending platform risk, regulation, the liquidity of the investment, and keep monitoring the performance of lending platform(s).

 

Overall, the digital lending market is poised for significant growth in 2023, and investors have many opportunities to profit from this trend. However, as with any investment, it’s important to research and invest wisely.

Additional Reading:

 

Digital Lending and FinTechs are Changing: The Impact on SME Lending

 

Rise of Digital Lending

 

Does Digital Lending Add Value to an Investor’s Asset Mix?

About Exaloan

Exaloan is the leading technology provider for institutional investments in digital loans. Its mission is to close the global funding gap for individuals, entrepreneurs and SMEs by connecting institutional capital with digital lending platforms. By operating a global B2B marketplace, the company opens up digital lending as a new asset class.. As an independent agent and validator, Exaloan provides a fully digital investment infrastructure with a standardized risk assessment of each single loan through its Loansweeper™ platform. At the core of its business, Exaloan uses big data and predictive analytics to generate an independent real time credit analysis as well as dedicated insights and reporting for institutional investors, banks, and lending platform partners. Insights cover topics such as sustainability reporting, advanced portfolio analytics, and market research.

Behind Exaloan stands an experienced team with extensive know-how in the areas of quantitative portfolio management, capital markets, machine learning, and software development.

 

If you want to find out more, reach out to us.

We look forward to working with you!

Get in touch!

Share it with your friends!

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Digital Lending and FinTechs are Changing: The Impact on SME Lending

Cover image for Exaloan blog Fintech startups impact on digital lending for SMEs

Digital Lending and FinTechs are Changing:
The SME Finance Scenario

Cover image for Exaloan blog Fintech startups impact on digital lending for SMEs

Img1. Digital Lending and FinTechs are Changing – Exaloan AG

Recent technological advancements have completely changed the financial services value chain. Furthermore, the utilization of behavioural and psychometric information, as well as social media traces, has enabled various non-banking financial institutions (NBFCs) to bridge the funding gap, which still exists and FinTechs have started tackling it for the Micro, Small, and Medium Enterprises across the globe. FinTech has provided a hassle-free path to flexible and customized credit products by targeting niches in the SME lending sector. 

Use of Digital Payments (after Covid) 

Banks have never been more diverse in terms of the products and services they provide to their clients. However, Banks must not lose sight of the fact that lending is critical to their profitability and relevance, as well as a foundation for attracting and initiating deeper connections with clients. Lending can then serve as a launching pad for a bank to offer a broader ecosystem of financial and non-financial services including networking/access to markets and recognition, information and educating the customers. 

 

Opportunities for Banking sector in SME lending scenario 

Banks may seize new opportunities with SMEs and gain a larger share of the projected growth by reinventing and modernizing their business-lending procedures. Banks, on the other hand, face issues in the SME lending market since many continue to utilize outdated business models, rely on legacy systems, and regard SMEs as corporate entities.  

According to McKinsey, reimagining SME lending can have a major influence on bank operational performance, including:

  1. Increased conversion rates result in a 10% to 15% increase in revenue.
  2. Gains in operational efficiency of 20 to 30 percent as a result of digitizing the customer journey and reducing touch-time.
  3. Reduced the risk of nonperforming loans (NPLs) by 10% to 25% by improving risk models and employing analytics to make automated choices.

The SME sector, which contributes significantly to GDP, exports, and jobs, continues to play an important role in driving growth. However, despite their demonstrated growth record and contribution to the economy, financial institutions have underserved SMEs. This circumstance occurs for a variety of reasons. Financial institutions consider the category as high risk due to its heterogeneity. The majority of enterprises are family-owned, and promoters prefer funding from unorganized sources at exorbitant rates. Inadequate credit history inhibits banks’ capacity to assess such units’ credibility. Banks face challenges due to poor record keeping and financial planning. 

 

Fintech's Changing Face 

Fintech is no longer only a disruptor; it is assisting SMEs in becoming more bankable by alleviating critical pain points such as quick access to credit. It is making inroads into the financial services business as an innovator and enabler, with the financial muscle to bear the risk of loans and recoveries. Fintech lenders, having a technology advantage and free of legacy baggage, are acquiring a competitive advantage over traditional banks. The statistics are telling: 

To quote PwC: 

  1. 67% of traditional financial institutions are already feeling the heat
  2. 84% of traditional financial institutions are embracing disruption
  3. 95% of traditional financial institutions are expected to increase fintech partnerships in the next 3 to 5 years
An image shows the global fintech scenario and how Fintech startups impact on digital lending for SMEs

Img2. Global FinTech Scenario (Source: Fintech Magazine, 2021; World Bank, 2022; Statista, 2021; Businesswire, 2021)

Final words: 

Digital lending and fintech are transforming the SME finance landscape. Banks are trying to adopt the digital environment and automating backend activities to reap both short- and long-term benefits but still there is a long way to go. End-to-end digitization will not only help banks reduce decision turnaround times but will also reduce the processing costs associated with lending to these borrowers. This will not only give prompt access to funds but will also reduce the cost of these loans. Financial institutions are experimenting with robotics, blockchain, artificial intelligence, big data, and analytics. New-age fintechs like Exaloan AG has potential to revolutionize the SME finance landscape. With its innovation and new-age products such as Loansweeper, which provides access to millions of investable loans operated by verified lending platforms.It brings transparency and standardization across the industry and assist in real-time decisions making, thus also enabling institutional investors reaching out to the underserved SME clients. These technologies enable banks to transition from traditional collateral-based funding methods to enhanced cash-flow lending. Some reputable FinTechs offer services such as converting scanned financial bank statements into customized formats for quick decision-making and offering borrowers digital platforms for easy access to funding. Banks and fintech will need to collaborate to provide customized digital products while also guaranteeing that the majority of SMEs can benefit from traditional lending channels. 

References:

Statista (2021). Digital Payments report 2021. https://www.statista.com/study/41122/fintech-report-digital-payments/ 

 

Cag. (2021). 17 Fintech Trends You Should Know About https://fintechmagazine.com/sustainability/17-fintech-trends-you-should-know-about-ultimate-guide 

 

World Bank (2022). COVID-19 Drives Global Surge in use of Digital Payments https://www.worldbank.org/en/news/press-release/2022/06/29/covid-19-drives-global-surge-in-use-of-digital-payments 

 

Zai (2022). The outlook for the global financial technology (fintech) industry https://blog.hellozai.com/the-outlook-for-the-global-financial-technology-fintech-industry 

About Exaloan

Exaloan is the leading technology provider for institutional investments in digital loans. Its mission is to close the global funding gap for individuals, entrepreneurs and SMEs by connecting institutional capital with digital lending platforms. By operating a global B2B marketplace, the company opens up digital lending as a new asset class.. As an independent agent and validator, Exaloan provides a fully digital investment infrastructure with a standardized risk assessment of each single loan through its Loansweeper™ platform. At the core of its business, Exaloan uses big data and predictive analytics to generate an independent real time credit analysis as well as dedicated insights and reporting for institutional investors, banks, and lending platform partners. Insights cover topics such as sustainability reporting, advanced portfolio analytics, and market research.

Behind Exaloan stands an experienced team with extensive know-how in the areas of quantitative portfolio management, capital markets, machine learning, and software development.

 

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Digital Finance: Driving Financial Inclusion in Africa | Part 2

Digital Finance: Driving Financial Inclusion in Africa | Part 2

In one of our last blogposts, we begin discussing the impact of the global digital lending industry on financial inclusion, based on the example of Africa. In this blog post, we will go more into detail exploring the different variations and business models that fall under the umbrella of Digital Lending.

The Digital Lending Landscape | Sub-Saharan Africa 

The visualization below shows three main lending models: Bank Originated Digital Lending, Balance Sheet Lending and Peer-to-Peer lending. We will explain these models based on their implementation in Africa and discuss how these models are linked to the development stage of the financial system and its African participants.

Source: based on FSI Insights on policy implementation No 27; Regulating fintech financing: digital banks and fintech platforms

Bank Originated Digital Lending entails banks partnering up with mobile service providers or startups to deliver their loans through digital channels. These offerings were the first to come to market, piggybacking off newly emerged mobile money systems and making use of established deposit-taking institutions. The first such lending scheme to emerge in Kenya was M-Shwari, a collaboration between the Commercial Bank of Kenya (CBK) and Safaricom, the provider of the M-Pesa mobile wallet. Bank-based digital lending is among the best-regulated form of digital lending in Africa since banks fall under the jurisdiction of local regulators.

Other players in the Sub-Saharan Digital Lending Ecosystem are Balance Sheet Lenders. They lend out proprietary funds acquired via capital or debt markets. This sector has grown significantly with notable players such as Branch and Tala, two Silicon Valley affiliated companies operating in Emerging Markets across the globe. Unlike banks these lenders do not take deposits and fall out of most of the traditional regulatory framework. These types of lenders have also been bogged down by controversy connected to the often extremely high interest rates that are not always communicated transparently to the borrowers (the Africa Report, 2021), prompting moves towards more regulatory scrutiny.

According to the 2nd Global Alternative Finance Market Benchmarking Report (2021), the global market share of Balance sheet consumer and business Lending in 2020 reached 36% of the estimated alternative finance loan volume, which amounted to more than 40 billion dollars.

Lastly the field of Peer-to-Peer Lending grew to become the dominant alternative lending model in Sub-Saharan Africa, reaching a total volume of 769 million in 2021, up by 50% from the previous year. A good example is Nigeria based Kiakia, which offers consumers both loans and investments. This field is however also quite dominant in the agricultural sphere, with offerings such as thriveagric or farmcrowdy allowing investors to finance the seeding stage which will be paid back with the harvest. In Sub-Saharan Africa P2P lending has become the dominant model in the alternative finance market.

The advantages of P2P lending are far-reaching: it does not only create more financing opportunities but also gives retail investors a good alternative to established asset classes, which are underdeveloped especially in the African context. It also enables to invest directly into the local economy. Most importantly perhaps, digital lending has proven to reach borrower segments that are excluded by traditional banks.

 

Market Share of Alternative lending products in Sub-Saharan Africa 2020 Source: The 2nd Global Alternative Finance Market Benchmarking Report (2021)

 

The advantages of P2P lending are far-reaching: it does not only create more financing opportunities but also gives retail investors a good alternative to established asset classes, which are underdeveloped especially in the African context. It also enables to invest directly into the local economy. Most importantly perhaps, digital lending has proven to reach borrower segments that are excluded by traditional banks.

 

Banking Status of Borrowers from Digital Lending Platforms across Regions (2020)

Source: The 2nd Global Alternative Finance Market Benchmarking Report (2021)

 

Currently relatively unconstrained by regulatory hurdles both balance sheet and peer-to-peer lending have shown double and even triple digit growth over the last few years. There are however still significant hurdles impeding market progress, most importantly a lack of transparency and comparability of the loan originators and the loans themselves. An investor willing to invest a large amount in the sector will invariably run into the problem that it is very difficult to assess the creditworthiness of companies and debtors from the outside. Furthermore, the availability of capital across lenders, but in particular in P2P lending, remains very limited. Nigerian lenders for example are currently only able to fund around 10% of eligible loans due to a lack of available funding. In 2020, the reported institutionalization rate on lending platforms stands at merely 30%. Although this is an increase compared to only 21% in 2019, bringing in cheaper money will likely be essential for sustainable growth.

 

Funding Source in Digital Lending in Sub-Saharan Africa 2020

Source: The 2nd Global Alternative Finance Market Benchmarking Report (2021)

 

In conclusion, new business models in digital lending hold great promise, especially in Africa, to improve financial inclusion. There are however still significant hurdles that need to be overcome before its full potential can be fulfilled.

At Exaloan we believe in the transformational power of technology to close the global financing gap. By providing a marketplace to connect Lending Platforms with Institutional Investors we aim to accelerate the transformation of the global financial lending markets toward more equitable and fair lending across the world – Including Africa.

 

 

 

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Digital Finance: Driving Financial Inclusion in Africa

Digital Finance: Driving Financial Inclusion in Africa

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How digital Lending reaches previously underserved populations

Getting an overview over the fintech digital lending landscape can seem daunting and confusing, so we would like to use this blogpost to give an overview over the industry and how it has progressed in recent years based on its development in Africa.

 

 

Traditional lending by banks comes with high barriers for entry that has historically excluded large parts of the population. This is especially true in Africa, where for the longest time most people did not even have a bank account to deposit and transfer money. As the graph below shows, most countries in sub-Saharan countries had financial inclusion rates of less than 50% in 2011.

 

2011: Account ownership at a financial institution or with a mobile-money-service provider (% of population ages 15+)

 

Source: Demirguc-Kunt et al., 2018, Global Financial Inclusion Database, World Bank, last accessed: 6/17/2021, own visualization

\Note: the following countries have been excluded from the original visualization: Angola, Comoros, Djibouti, Burundi, and Sudan

 

Without formal employment or address and a credit history, traditional financial institutions are unwilling and unable to provide individuals or their informal businesses with credit. In developing economies, the first alternative lending models in the shape of microfinance institutions emerged in the 1970s. These institutions typically had a local focus and aimed to establish community-based lending behavior, that although it minimized default rates, was both high in costs and maintenance, and hardly scalable. As a result, thereof, large parts of the wider population in many countries remaining unbanked and without access to credit.

 

This only began to change with the emergence of mobile phone technologies in the 2010s. In the space of a few years the financial inclusion rate more than doubled in sub-Saharan Africa (Mastercard, 2020). With the introduction of M-Pesa in Kenya people suddenly had access to mobile wallets, first to send and receive money, but soon also to borrow. This development was not only limited to Africa: globally 1.2 billion adults have obtained an account since 2011, including 515 million since 2014. Between 2014 and 2017, the share of adults who have an account with a financial institution or through a mobile money service rose globally from 62% to 69%. In developing economies, the share rose from 54% to 63%. As the graph below shows, a large part of this growth was driven by mobile accounts, which grew disproportionately from 2014 to 2017 in many African countries.

 

Annualized growth of account ownership by type (% population age 15+) 

Source: Demirguc-Kunt et al., 2018, Global Financial Inclusion Database, World Bank, last accessed: 6/17/2021, own visualization

Note: the following countries have been excluded from the original visualization: Angola, Comoros, Djibouti, Burundi, and Sudan

New companies sprang up to capitalize on this growing trend, using data collected by users’ mobile phones to calculate default probabilities. Consumers previously excluded from accessing capital had the ability to quickly borrow money in emergencies or to fund and grow their businesses. The visualization below breaks down the regional allocation of mobile money accounts as a percentage of all accounts in 2017. One of the main drivers in Sub-Saharan Africa has been Kenya, which is also the first country to propose specific legislation to regulate Digital Lending companies.

2017: Account ownership at a financial institution or with a mobile-money-service provider (% of population ages 15+)
 

 

Source: Demirguc-Kunt et al., 2018, Global Financial Inclusion Database, World Bank, last accessed: 6/17/2021, own visualization

Note: the following countries have been excluded from the original visualization: Angola, Comoros, Djibouti, Burundi, and Sudan

 

Digital Lending as described above includes a host of different types of companies and business models. However, all share one common hurdle. Digital lending processes ultimately require digital funding processes to bring that market to scale, and many platforms lack the appropriate funding sources to fulfil the demand for credit. This is where Exaloan comes in by standardizing and automating digital funding processes for institutional investors and digital lending partners. If you are interested to know more, send us an email at info@exaloan.com and request a meeting or a demo.

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Sharia-Compliant Digital Lending

Sharia-Compliant Digital Lending

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With global mobility down and no prospects for physical experiences in foreign lands insight, we are taking a virtual trip towards the Global Middle East! Towards Islamic credit markets, and towards yet another exciting opportunity in digital lending!

A Brief Introduction to Sharia-Finance:

Islamic finance refers to how businesses and individuals raise capital in accordance with Sharia-law, a set of rules that comply with the Quran, the Sacred Scripture of the Muslim community. Key concepts include the avoidance of riba (usury) and gharar (ambiguity or deception). Money is seen as a representation of value, not an asset in itself, leading to the saying’ money cannot make money.

Therefore, simply lending capital with interest (and therefore for profit) is considered riba – and prohibited under Islamic law.

The concept of risk-sharing must be considered when raising capital in accordance with Sharia law. The Sharia-compliant product uses a bank fee rather than an interest payment structure while keeping product features very similar. Lending activities must happen within a banking framework in which the financial institution shares in the profit and loss of the loan it underwrites. To comply with the risk-sharing approach of Sharia-compliant lending, the Islamic bank may pool investors’ money and assume a share of the profits and losses.

Why Sharia-compliant Digital Lending?

As the Islamic Finance Marketing Experiment 2020 found, consumer preferences for Sharia-compliant lending products over conventional products are relatively un-elastic when it comes to religious borrowers. In a randomized experiment in Jordan, the researchers found that Sharia-compliance increased the application rate for loans from 18% to 22%, which equates to a 10% decrease in interest rates.

*Source: Islamic Finance Marketing Experiment 2020

These barriers add to the intrinsic dislike of conventional loans for religious borrowers. The findings suggest that religious considerations are partially responsible for the low utilization rate of household credit in developing countries with a large Muslim-population. High lending rates, an exclusive attitude, complicated procedures, and bureaucratic policies of traditional FIs are common obstacles reported by (M)SME when getting a loan. Muslim-majority countries have a 24% lower participation rate in active borrowing from banks (10.5% versus 7.9%) and a 29% lower rate of having a bank account (40.2% versus 28.6%).

Sharia-compliant digital lending products could not only lower access barriers to Islamic finance, but they could also contribute to mitigating the region’s financing gap, which sits at $335bn for South Asia and $186bn for the Middle East. Digitization could also propel Islamic finance’s growth in general, which is experiencing moderate to sluggish growth (1-2% in the next 2-3 years, S&P Moodys 2020).

Global investments in Islamic economy-relevant companies are already rising. In 2020, VC and other direct investments amounted to 11.8 billion dollars (Dinar Standard , 2019). Almost half of the investment volume, namely, USD 4.9bn, is invested in Islamic Fintech, highlighting the objective of putting technology-enabled finance to use to mitigate the historical slagging growth of Islamic Finance in MEASA.

Notably, the UK accounts for the most registered Islamic Fintech Firms with 27, followed by Malaysia, the UAE, and Indonesia (IFN Islamic Fintechs, 2021). A growing number of more than 120 Islamic fintech firms already offer Sharia-compliant financial products, many of them in the form of digital loans. Examples of Sharia-compliant digital lending platform include MicroLeaP (Malaysia), Dana Syriah (Indonesia), Nusa Kapital (Malaysia)…

Tradition meets Innovation: The Opportunity

According to Dubai International Financial Center (DIFC), Sharia-compliant assets currently represent 25% of banking assets in the Gulf Council Countries (GCC) and 14% of total banking assets in MEASA. Globally, Sharia-compliant AuM are expected to reach $3.8 trillion by 2023, almost doubling their 2020 volume of $2 trillion and growing at a CAGR of 10-12%.

The S&P Islamic Finance Outlook 2020 emphasized the need for inclusive standardization by relevant authorities and stakeholders to sped up Islamic finance advancement. It also hints at the role of Fintechs for supplying the necessary innovations with regards to products and technological infrastructure and for achieving a financial landscape that aligned with ESG objectives.

While market growth remains paced, it is gaining traction: Sharia-compliant digital lending operators in Indonesia have already doubled their Assets under Management between October 2019 and October 2020 (OJK, 2020). As recently as February 2021, the Bank Syariah Indonesia (BSI) was established after consolidating three state-owned banks. BSI has a net worth of $1.4 billion and works on the efficient integration of the three forming banks: Bank BRI Syariah, Bank Syariah Mandiri, and Bank BNI Syariah. The BSI shall allow platforms to better access credit scoring, e-KYC, and digital signature services. It will also integrate customer data from the forming three banks to help fintech companies partnering with BSI to offer services to its customers.

The digital lending market volume in the Middle East (MEA) has recently experienced impressive three-digit annual growth rates with complementing investments in several Arab lending platforms. Excluding Israel from the Middle East region, it is found that 95% of this digital lending volume stems from Debt-based instruments, roughly 5% from equity-based models, and 0.18% from non-investment models such as Waqf (donation)-based crowdlending (CCAF, 2019).

The biggest Sharia-compliant platform for SME lending in gulf countries is beehive, with approximately $170m in facilitated loans in 2020 (as of spring 2021). The platform recently partnered with government entities to roll-out a digital financing platform for micro and small Saudi Arabia enterprises. Across the UAE region, retail investors account for the dominant share of digital loan investments, with 90% against 10% institutional investors.

Another underlying driver is that since 2017, Islam is the fastest-growing religion in the world. It is already the second-largest religion after Christianity, and by 2025, approximately 30% of the global population will be Muslims. Sharia-compliant lending platforms are not only rolling-out products that their customers desire. They are entering an underserved growth market, while also captivating the general socially responsible investors and borrowers due to an emphasis on fair and equitable treatment of counterparties in the financing agreements.

We at Exaloan are excited to see where the market is headed! If you are interested in country-specific details, please contact research@exaloan.com.

 

Further Read / Interesting sources:

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Credit Rating Agencies in Digital Lending

Credit Score rating based on debt reports showing creditworthiness or risk of individuals for student loan, mortgage and payment cards, concept with business person touching scorecard on screen

Credit Rating Agencies in Digital Lending

One of the fundamental issues for investing in digital lending stems from a lack of standardization and transparency in the market. Fragmented into hundreds of lending platforms, with equally many rating methodologies and rates, comparability among investment opportunities is a nightmare. Furthermore, lending platforms typically act as loan originators, brokers, and rating agencies at the same time. It’s an encompassing business model that has enabled digital lending to scale up rapidly, but it also creates an array of problems:

Crooked incentives

Agency problems root in the fact, that digital lending platforms benefit from scaling loan originating. A recurring feature of the digital lending market as of now is an excess demand for credit compared to available financing volumes . A common problem with platform business is balancing two sides of one coin: in this case supply of financing with demand for credit. With credit being a function of capital available, the incentive to jack up interest rates to attract and retain investors is imminent.

In the long-run, the resulting problems are various: painful interest obligations for borrowers, adverse selection of the crowd, the threat of sliding into bad credit segments, a weakened competitive position, and high risks for the lending platform’s longevity.  

In traditional fixed income markets, agency problems are mitigated by having not the originator, but an independent rating agency assesses the creditworthiness of the borrower.

So much for (resolving) agency problems.

Intransparency

Another problem is information asymmetries. Who’s to say the credit score assigned to the loans is trustworthy? One might argue, that if platform A’s rating cannot be trusted, one can always pivot to platform B. Bad for platform A. And a cumbersome and annoying process for the investor. And then again, how will she compare her investment opportunities if each platform has a unique rating scale and methodology to assess risk? How is she going to decide? Trial and Error? Seems unsustainable.

The lack of transparency, comparability, and standards in digital lending represents an enormous hurdle for investors. It also puts a ceiling on the industry as a whole with respect to cross-platform investments, scalability, and further institutionalization. Without a unified credit score, the comparability of investment quality across platforms is a nightmare. The problem is only amplified regarding investments across markets.

In traditional fixed income markets, these information asymmetries between borrowers and investors are mitigated by independent rating agencies. In an independent assessment, a unified score is derived that enables the investor to compare and select amongst various investment opportunities. The rating assigned thereby shows an agency’s level of confidence that the borrower will meet its debt obligations as previously agreed. Some risk and uncertainty always remain, and investors are obliged to trust the agency and the results of its assessment. But having a third-party validator is best practice. Most of all it is helpful in creating more liquidity.

So much for (resolving) information asymmetries.

Why don’t we have an independent rating agency in digital lending?

A rating agency in the digital lending market must score millions of individual loans based on a unified methodology that can be applied to the entire ecosystem in real time. Quite frankly, it may seem unnecessary given that most platforms already have tested and trustworthy credit risk assessment processes in place. However, for the sake of scalability and institutionalization, it will be necessary. And it must come from an independent party.

It’s number crunching at scale. It requires massive amounts of qualifiable data. But the beauty of this new lending era lies in being digital. Which means, the underlying processes are automatable, and which means the ecosystem is highly scalable.

Introducing Loansweeper

We have developed software, that derives a standardized and platform-agnostic credit score in real-time, enabling investors to get a transparent and comparable risk assessment on investment opportunities in digital lending. From an independent third party. And all in on hand on our global B2B marketplace across numerous lending partners.  

We developed our software because digital lending will fundamentally disrupt the global credit markets. It is already happening with regards to the loan application and assessment process. However, to open this market to institutional investors, we built the necessary technology to not only digitize, but standardize the funding process in digital lending.

If you want to learn more about how we can provide you with one interface to the source, score, and ultimately fund millions of individual loans across markets, reach out to us.

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Rise of Digital Lending

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2020 – A year that put a spotlight on Digital Lending 

 

After an exciting, disruptive, and challenging year 2020, it is time for us to recap the rise of digital lending. How did 2020 shape the nascent industry, and where is it headed? Let’s have a look.  

 

 

The Origins – Building on the Crowd

Digital lending emerged in line with the expansion of digital financial services. Its origins are thereby largely based in Crowdfinancing.

 

Crowdfinancing is a concept that describes the opportunity for individuals, entrepreneurs, and companies to raise funds online by applying to a pool of investors, typically in the form of a campaign. Crowdfinancing platforms lower the threshold for borrowers and investors to partake in a transaction alike, by enabling direct and more fragmented interactions. The use of technology allows for improvements in speed, transparency, and costs. Various technologies are deployed to automate the entire credit process, from online-only applications, to data-driven risk assessments and automized matchmaking and allocation processes. Furthermore, borrowers can directly test the market value of their endeavor by being directly exposed to potential financiers.

 

Common Crowdfinancing models include Equity-based Crowdfunding or “Crowdinvesting”, Reward-based Crowdfunding, Donation-based Crowdfunding, and ultimately Lending-based Crowdfunding or “Crowdlending”. Crowdinvesting thereby describes a form of equity financing, while Crowdlending is a debt-based financing solution.

 

In Equity-based Crowdfunding, the loan is granted in the form of shares or mezzanine financing instruments. Accordingly, the investor acquires a share in the company and participates in its success, i.e., in the profits.

In Reward- and Donation-based Crowdfunding, the borrower may provide a material consideration to his investors for contributing their capital, although the reward is not necessarily of financial nature, but may be idealistic. With donation-based Crowdfunding, the investor does not receive any financial or material consideration for his investment, but donations are made for ideological reasons only.

Lastly, lending-based Crowdfunding describes a concept akin to a bank loan. As with any debt security, every investor that financially participates in the corresponding crowdlending project receives a fixed interest rate in return for his investment for a certain period of time and is repaid the principal.

 

The latter is what is also commonly referred to as Digital Lending.

 

 

The Rise – Redefining the Lending Value Proposition and Driving Financial Inclusion

Lending is traditionally banking business. In more established credit markets, efficiency concerns drive digitization in the credit process, enabled by technological advancements and changing business requirements. Speeding up the lending process by means of automation is a significant advantage of Digital Lending over traditional lending products. It enables players to cater to changing consumer preferences for speedy and flexible financial services. Through automation, Digital Lending has extensively reduced the amount of time needed to obtain a loan from a couple of months to just a few hours. Furthermore, procedures from application to risk assessment and disbursement are becoming more transparent. Meanwhile, a lot of waste linked to cumbersome, manual processes is reduced by paperless and largely data-driven systems.

 

In developing markets, the lack of traditional credit options has led to an enhanced proliferation of digital financial services. Globally, millions of people still lack access to traditional financing institutions due to structural barriers or simply because they do not fulfill conventional customer requirements. The result of an insufficient financial infrastructure is that a suboptimal amount of capital finds its way into these economies. By offering digitized solutions, digital lending platforms can also contribute to financial inclusion and make credit more widely accessible by reaching previously excluded borrower segments. Since credit is the backbone of economic growth, improved lending services are widely regarded as a key element in financial and capital systems. The potential value of Digital Lending for the real economy is largest in emerging economies that are characterized by a flawed banking system, high demand for credit and a young, and tech-savvy population.

 

Digital Lending also opens a new segment for investors, leading to a broader, more diverse investable ecosystem. Compared to traditional asset classes, Digital Lending thereby offers an attractive new investment opportunity characterized by steady income generation, short duration and competitive returns. It can be accessed by technology-enabled players who can exploit process efficiencies using standardized default predictions based on qualifiable data and applied machine learning techniques.

 

 

Current Situation – New Regulation and Institutional Capital Needed

Digital alternatives thrive, where traditional services and products fail or become outdated. As of now, only a small fraction of lending activities is truly digitized. Of the trillion-dollar global lending market, a few hundred billion in transaction volumes are covered by digital lending platform activities every year – although at rapidly increasing growth.  

 

We count more than 1,500 digital lenders globally, facilitating around 300bn USD in digital credit on an annual basis. At the same time, we observe that, on average, less than 20% of approved credit applications ultimately receive financing with the existing (mostly retail-based) investor basis. The fact that the demand for digital credit widely exceeds available funding volumes is a worldwide phenomenon. Now that the pandemic and subsequent economic scrutiny has forced many private investors to retreat their capital off digital lending investments, this problem is likely to persist.  

 

The findings are critical, given the already existing financing gap of more than 5bn USD annually, which hinders in particular SMEs in developing countries to receive appropriate funding via traditional channels. 

 

With these considerations in mind, several regulators in emerging economies have adopted progressive Fintech frameworks to incorporate digital financial services – and digital credit – into their conceptualizations for new, inclusive, and sustainable economic systems. With the groundwork of Fintech regulations almost done, in Southeast Asia, it is assumed that by 2025 around 8% of the local lending market will become digitized, representing more than 100bn USD in aggregated loanbook values across the region (Google, Bain & Temasek, 2020).

 

A significant development this year has also been the proposal for a new European crowdfunding regulation by the European commission. The regulation, which is aimed to come into force in November 2021, acknowledges not only the importance of a Pan-European, harmonized regulatory framework for digital lending activities, but also the difficulties for the necessary institutional capital to enter the market. Proposed measures should ease the entry of institutional money.

In line with these developments, few prominent players are opting for institutional capital as their only source of funding in the future, as the AltFi team reports in their alternative lending predictions for 2021.

 

While these are favorable outlooks, one may put the careful caveat that the necessary technology for standardized, large-scale institutional investments in digital credit is yet to be implemented. Nonetheless, the introduction of large-scale institutional capital is certainly what Digital Lending needs to transform successfully into a full-fledged digital financial market. 

 

 

Outlook 2021 – Great Fundamentals & Key Year Ahead

Overall, 2020 has been a stress-test for the industry, highlighting the advantages and challenges with Digital Lending activities. Regulators all around the world, established financial institutions and governments locked their focus on digital lending platforms, closely eying their ability to distribute capital and process loan request rapidly and efficiently without personal contact over the past months of the pandemic.

 

We have seen businesses being driven out of the market as their investor base crumbles. Other players have mobilized to adopt and conquer the challenges of 2020 successfully by means of new collaborations and improved risk management.

Digital lending is still relatively young, but its sound fundamentals and far-reaching value proposition indicate, that the credit platform economy will continue to shape lending as we know it.

 

At Exaloan, we look forward to an exciting new year for digital lending and welcome the unique challenges and opportunities of 2021!

 

PS: Which topics would you like to read about in 2021? Let us know, which aspects of the digital lending investment ecosystem you would be interested in learning more about by submitting your feedback via info@exaloan.com. 

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Revisiting the effect of COVID-19 on the digital lending market

Revisiting the effect of COVID-19 on the digital lending market

Months into the pandemic, we are taking another look at the global digital lending market and its response to COVID-19. As we approach the last weeks of 2020, loan origination volumes are still significantly down compared to 2019 levels, but a few signs of a potential recovery are starting to emerge. At the same time, further consolidation among lending platforms is likely. Credit defaults have remained quite well under control, albeit the full effect of the COVID-19 shock on lending platform loan books remains to be monitored. Some fintech lenders have demonstrated great flexibility in expanding their lending activities under government-backed programs, which indicates a sound basis for further recovering lost ground in terms of origination volumes. Having access to an institutional investor base thereby continues to be key for digital lending platforms’ future growth.

 

Origination volumes & performance

We see an expectable decrease in origination volumes across the product palette, particularly for consumer loans and mortgage loans. This trend is manifesting and likely to continue for a short-to-medium term outlook. 

In Indonesia, one of the largest digital lending markets in Southeast Asia, with more than 9bn in originated loans as of September 2020, credit demand is slowly returning to pre-COVID levels, but loan performance continues to worsen. TKB, a measure of non-performing loans (NPLs) after 90 days, increased 4.8% YTD, standing at 8.27% in September 2020. In January 2020, TKB stood at only 3.6%. 

Looking at Europe, origination volumes are also regaining pace. For Mintos, one of the largest European players, monthly originations in September stood at 87m EUR (Euro-Area only), a volume comparable to October 2018 levels. Nonetheless, the development marks a steep recovery from 40m EUR in April, especially since several loan originators listed on the Mintos marketplace have been defunct or closed operations during the summer. 

Finland-based digital lender Fellow Finance also shows a reduced amount in funded loans, standing at 11.4m EUR in October 2020, down from 15.5m in January, but up by about 37% from the April low of EUR 8.3m. Since average interest rates have been raised by roughly 2% across the board since Q2 2020, demand for new loans has been sluggish. Nevertheless, a significant amount of loan applications remains available for funding, and further investment interest following the higher rates is likely.

 

Loan performance across the digital lending segment is holding up reasonably well so far. With extended repayment schedules and extensive restructuring, some established lenders have managed to contain pre-COVID adjusted defaults. Still, we observe that delinquencies are starting to rise across outstanding loan origination vintages for several fintech lenders. With tighter credit conditions and modified risk assessment models, new loans originated after the COVID shock in April are performing seemingly well. However, the evolution of default rates across the loan book remains to be monitored in the upcoming months. 

 

 

Collaboration and institutionalization

Apart from demonstrating the need to rapidly deploy funds through technology, the pandemic has also invoked an unprecedented wave of collaboration between governments and Fintech companies. French SME lender October secured almost 160m EUR in support of European SMEs. The platform is now offering state-backed loans to French companies in the tourism sector as well as state-guaranteed loans to Italian SMEs. The Danish lender Flexfunding has also secured state-support, now offering specialized debt-instruments to Danish companies. In the UK, Europe’s most established digital lending market, the Coronavirus Business Interruption Loan Scheme (CBILS) has already accredited more than 100 bank and non-bank lenders to help UK’s small businesses affected by the pandemic in accessing finances.

 

Positive investment signals in Fintech lenders also come from the private sector. Germany-based SME lender Creditshelf recently set up a new direct loan fund, backed by its founders and EIF, to support German SMEs hit by Covid-19. In a similar fashion, the largest German Fintech lender, Auxmoney, secured 150m Euro from US private equity firm Centerbridge Partners to expand its leading market position and announced to be funding up to EUR 500m in loans along with other investors on its own marketplace.

 

With retail investors retrieving their capital during economic uncertainty, such collaborations are vital for Fintech lenders to continue distributing loans efficiently via their tech platforms. Qualifying as eligible distributors of government aid schemes also signals increasing acceptance of Fintech lenders into the mainstream. 

 

Outlook

The pandemic is the first real stress-test for the industry. While some digital lenders have found themselves at a crossroads, several established players have adapted well to the circumstances and struck new partnerships to cater to borrower segments in need of funding. Still, the most recent events have shown that access to a broad institutional investor base continues to be the essential growth driver of marketplace lenders. At the same time, loan selection and analysis will be essential to generate a solid investment performance for investors in digital lending.

If you want to learn more about how we can provide you with one interface to the source, score, and ultimately fund millions of individual loans across markets, reach out to us.

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