The Next Frontier for Payments: Lending

Gavin Lock, COO & Board Director, Senjo Group

Gavin Lock, COO & Board Director, Senjo Group

For small businesses in every market, a perennial challenge has been – and continues to be – securing payment for their products and services so that they can maintain sufficient working capital to keep the business running.

Most merchants face funding-related issues at some stage, and in regions like Asia where payment settlement can be as long as T+5 or even longer, the settlement risk this exposes merchants to can be substantial and a real concern when it comes to growing and scaling their business.

And for smaller businesses which don’t have the scale or volume to negotiate for an improved settlement, the settlement gap can create significant business challenges.

But thanks to the innovations driven by new technologies, these issues look as if they won’t remain a problem for much longer.

The traditional payments sector is on the verge of change as providers are increasingly partnering with alternative lenders to bridge the settlement gap, using new technologies such as big data and AI to venture where banks have previously declined to go. Could this be the start of a new way for SMEs to access traditional capital markets for funding more easily?

What is alternative lending?

Put simply, alternative lending is a range of loan options available to both consumers and business owners without participation from a traditional intermediary like a bank. Alternative lending comes in numerous forms, including Peer-to-Peer (P2P) or marketplace lending, balance-sheet lending, and point-of-sale (POS) lending.

As the model matures, alternative lenders are increasingly able to tap capital markets willing to lend in increasing amount to these types of borrowers – in turn increasing the numbers of solutions for merchants of all sizes.

With alternative lending providing additional solutions for SMEs, there are more financing options than ever before.

Traditionally, a merchant’s obvious option for short-term funding has been the established banks – which may be out of reach for SMEs for a number of reasons including cost, onerous creditworthiness requirements, or a lack of the scale to make the relationship profitable for the banks. Research by Deloitte shows that in Southeast Asia, fewer than 60% of SMEs in Indonesia, Malaysia, Philippines, Singapore, and Thailand have access to bank loans as a source of funding.

Using new technology to access capital markets

The Global Financial Crisis of 2008 meant that for many SMEs, funding dried up. A broader trend of disintermediation of the banks has been underway ever since with businesses large and small search for new ways of keeping the doors open without depending on bank financing.

The simultaneous rise of digital technology has introduced new, cost-efficient ways of sourcing credit.

With alternative lending providing additional solutions for SMEs, there are more financing options than ever before.

Where the banks’ legacy systems for assessing credit, for example, are relatively rigid and labor-intensive, being able to parse customer data swiftly and smartly enables alternative lenders to create credit scores very efficiently.

To end-users, much of this activity won’t be visible – they experience a quicker and cheaper transaction via a merchant whose convenience has improved.

However for merchants that are affected by settlement issues, the solution may be in sight – its now possible for payment firms to offer lending services and offer real-time settlements to merchants, essentially acting as a bank. The difference to other forms of lending is that this happens all through the payments processor so the transaction (or loan) is essentially executed via factoring.

Merchants would still have to be assessed for credit risk, just as they would when they approach a bank for a loan, but the approval process should be more seamless and faster, enabled by the advancement of technology and a pre-existing relationship with the payment service providers who have full sight of the merchants’ cash flow as well as control over the settlement of funds.

Payments acquirers can offer this service by partnering with specialist alternative financing providers who have a deep understanding of the payments value chain and who can effectively integrate into payment systems to deliver digital financing solutions.

Financing need not be restricted to existing payment receivables; it can also be used for future receivables (commonly) known as a merchant cash advance.

This is a real example of innovation within a payments product that bridges the gap in terms of the merchant when it comes to all-important funding.

Challenges on the horizon

Although alternative lending has seen rapid growth, the sector is relatively new and operates largely in a loose regulatory environment. In some cases, this has resulted in non-transparent business practices involving high risk. The P2P lending crisis in China in 2018 highlighted the consequence of a lack of regulation. China has since been cracking down on what they consider a riskier form of financing, leaving in place a much more carefully built ecosystem.

According to a World Economic Forum white paper, some of the global regulators’ major concerns about alternative financing options include investor protection, securities laws, data protection, and data collection. It’s imperative that the market develops responsibly and within a solid framework of regulatory oversight that ensures close cooperation between all parties.

A maturing market requires more attention

While many might consider alternative lending a nascent concept, they can’t deny its huge potential. With news of lenders who lost money investing in P2P lending frequently in the headlines, it’s easy to dismiss the sector as either fad or fraud. However, with more advancement in technology, close scrutiny from regulators and a general acceptance of new methods of lending, it's starting to catch on.

Embedding lending into payments is also beneficial from a valuation perspective, with investors also seeing the potential rewards. A payments business which differentiates itself through customer-centric product innovation and places an emphasis on deepening customer relationships could command a higher valuation than one that provides a commoditized service and competes purely on scale and price.

Just as the telecommunications industry experienced rapid disintermediation following the development of the internet over a decade ago, in the financial sector new technologies are requiring participants to raise their game or become irrelevant in a new era of network finance.

In an industry that is becoming more and more commoditized, going beyond payments and delivering essential access to capital is one-way firms can continue to add value and differentiate themselves.

Extending a lifeline to businesses under pressure to maximize working capital and manage settlement risk is a powerful offering – and both merchants and consumers will see the benefits early on.