Borrowing to invest has become established as the global norm for businesses. Whilst other approaches exist, the prevailing economic model is predicated on debt-fuelled growth.
This typically works best for larger corporations. These companies have assets that can be put up as collateral, and they are big enough that banks are willing to work with them because they are profitable.
For small and medium-sized businesses, the picture can be very different. These outfits do not need large sums of money; they may be seeking to borrow a few thousand or even a few hundred dollars. Banks’ fixed costs mean these are simply not profitable to administrate. Then there is the problem that they may have few or no assets to act as collateral. The existence of such assets is a fairly blunt tool for assessing the risk of repayment, but it is the one banks typically use. It is, of course, possible to credit score a business on other factors. But this is a relatively lengthy process and again, for small businesses, it is not worthwhile for the banks to audit them and enforce collection. The reality is that for the banks, the sums involved are not worth the trouble.
The result is that many SMEs struggle to secure loans to expand; the system is, de facto, stacked against them. Small business owners may resort to alternative forms of finance, often in the shadow banking system or worse. By nature, these can be considered unconventional and can carry high fees and punitive terms.
Risk and return
This is the way the world works for the majority of businesses. If you are large and have assets, then the banks are prepared to deal with you. If you are not, then you will either be charged substantially higher rates – since the money is effectively considered an unsecured loan – or you will be denied finance altogether.
Wish Finance, a start-up targeting the ASEAN market, deals with organisations that would never typically be served by the banking sector. These businesses are looking for an average loan of just $2,000, though the amount can be as little as $500. The upper limit is around $10,000. The term of these loans ranges from one to twelve months, and averages four months.
Although banks generally won’t deal with these sorts of amounts, it is not impossible for these SMEs to access credit. The problem is that the companies that offer it operate on a conventional model that assesses them with a set of narrow criteria that deems them high risk. Wish Finance’s competitors charge interest of somewhere in the range of 30-80% APR – a punitively high rate that makes them unattractive – and, paradoxically, an even higher risk for those who do take out a loan.
The wide-ranging collection of financial technologies that have given rise to the buzzword ‘fintech’ in recent years has much to offer in such situations. Wish Finance is leveraging a number of these technologies to offer meaningful solutions to SMEs in the ASEAN market that would otherwise struggle to secure a loan. Their model is expressly designed for cash-based small Asian merchants and service providers, and the company is currently running pilots in Singapore and Hong Kong.
There are several elements of the initiative that make it unique over the standard model applied by banks. Firstly, Wish Finance adopt a far broader approach to risk than the standard insistence on assets as collateral. The reality is that many asset-poor companies are perfectly healthy and have strong business models; it is just that they fail on this one measure. Wish Finance uses big data analytics to rate businesses and provide a credit score based not on assets but on cashflow. Machine learning techniques are employed to understand the probability of a business defaulting under a given payment plan. This cashflow-based credit scoring offers not just quantitatively but qualitatively different criteria on which to understand risk – opening up a whole new tranche of businesses that are eligible for loans and enabling smart decisions on how much to lend, and at what rate.
Secondly, the company has developed infrastructure to reduce risk in repayments. Whilst payments on a loan would typically be made as a fixed sum at the end of the month, Wish Finance works exclusively with merchants that use PoS systems, collecting repayments as a percentage (2-5%) of every transaction made through the terminal. In addition, every loan is protected by insurance against the bankruptcy of the borrower. Together, this range of measures enables Wish Finance to charge an average of 24% APR – right at the bottom end of their competitors’ rates, at worst, and just a third of the worst rates.
Lastly, the company is building trust and implementing fraud protection by using the Ethereum blockchain to create a transparent and immutable record of the whole portfolio of loans. The entire loans history will be recorded on the blockchain, including active, paid and defaulted loans. (The performance of active loans and associated transactions will also be published on the Tendermint blockchain.) These records will be anonymised and will never contain personal or commercial data connected to borrowers or customers. Nevertheless, it is possible to record dates, payment methods, repayment amounts and outstanding debts on the blockchain. The purpose of this feature is to make Wish Finance fully transparent – to regulatory bodies, borrowers, shareholders and prospective investors – without compromising sensitive data.
This is the approach – lean, transparent, fair, intelligent – that fintech allows businesses like Wish Finance to take to problems that the traditional financial sector is poorly placed to solve.