Why marketplaces might be better at lending

When I joined Zilingo in 2018, one my first tasks was to figure out how to provide loans to SMEs who were selling on our platform. Getting access to working capital was one of the biggest challenges these merchants faced and if you could help them get access to the right amount of capital at the right time at the right price, they could scale up their businesses rapidly. Southeast Asia has millions of such SMEs and there are many fintech startups in the region who are trying to solve this problem.

I worked on building this vertical for over 2 years and in the process learnt a lot about SME lending. One of the most interesting trend was large marketplaces offering a variety of financial services. While most start with payments, they quickly move in lending, insurance, investments etc. When it came to financial product to SMEs, these marketplaces seem to have an unfair advantage to serve their merchants.

Most, if not all, marketplaces have started offering financial services to their users. Grab set up a separate entity called Grab Financial, Gojek acquired 3 fintechs back in 2017. Bukalapak recently announced the launch of it’s fintech business unit called Buka Investasi Bersama. There are many more og such examples. This is not a new trend — Uber and Shopify have been doing this for their drivers and merchants for a while now. But, given the significantly lower levels of financial inclusion in Southeast Asia as compared to the US, marketplaces are be in a better position to offer these services as compared to pure-play Fintech companies, especially in the lending space.

There are 4 key reason behind why marketplaces can do lending to SMEs better-

  1. Access to transaction data which allows for a more live and updated credit scoring system
  2. Control on the flow of money by handling payments for good sold of the platform which allows to make collections more efficient
  3. Access to collateral in the form of the virtual storefront
  4. Ability to grow sales by increasing exposure which lowers risk of default

Let’s deep diver into each of these reasons

1. Translating transaction data to credit scoring

Marketplaces has access to very a unique data set about merchants which includes sales, return rate, product categories etc. which can be used to assess if a merchant’s business is likely to grow or not. A simple example — if a merchant sale has grown consistently 10% every month for the last 6 months, clearly they have gotten something right. A working capital infusion at this point can really help them procure more inventory at better prices and sustain the growth. This information, which gets larger with every new transaction, sits with the marketplace and thus they are in the best position to assess which businesses to offer working capital too.

2. Seamless repayments

Giving out money is the easy part. Collecting it is the challenge. Collections is a very expensive process and most lenders have entire departments dedicated to collections. However, within the marketplace setup, this is absolutely seamless. This happens as the lender, here the marketplace, can deduct instalments of a loan before making a payout to the merchant. The merchant doesn’t have to do any active repayment (reducing the risk of default due to non-intention to pay) and gets a slightly lower payout against their sales. What’s also amazing is that the loan can be priced as higher commission, so there’s no explicit interest which needs to be paid, making the user experience exactly the same irrespective if they have a loan or not.

3. A new kind of collateral

When getting a loan from a bank, businesses need to put down some collateral in the form of land, machinery etc. But what exactly qualifies as collateral — let’s take a minor detour here.

What is collateral?

According to Investopedia, “Collateral is an item of value used to secure a loan. Collateral minimises the risk for lenders. If a borrower defaults on the loan, the lender can seize the collateral and sell it to recoup its losses”. Most collateral today is something which has value and it can be translated in money easily (selling off a piece of land). However, if you decouple the two, and focus on “things which have value”, there are many more things which could have collateral. Reputation in society is a common form of collateral in informal lending systems. So you can think of collateral as something whose loss makes it, increasingly hard to earn money. Now this is doesn’t guarantee a lender return of their money, but can ensure that someone doesn’t default or if they do, make sure that they repay it some way or the other. It’s arguable on which format of collateral is more efficient as the one I just described can be used in a predatory format.

So back to marketplaces. The online storefront of the merchant can be used as collateral against a loan. If the merchant refuses to pay a loan, the marketplace could just block their storefront which would result in a decline in sales. Merchants who have large online business wouldn’t want this and would ensure they pay back loans on time. (Sellers on Amazon observe their rating very closely as a lower rating would get them blocked).

4. Boost sales in times of need

Last, and probably the most powerful weapon a marketplace has, is the ability to boost sales of a merchant who is struggling. Marketing teams at marketplaces have an arsenal of tools ranging from banners, boosting product listing, social media channels etc. with large amounts of traffic. This could be offered to a merchant to increase visibility and drive more sales. This ensure that as long as merchants are selling valuable products at the right price, they will get sales and thus can repay loans.

So to conclude, marketplace seem to be much superior in their ability to offer loans to merchants and more importantly collect their money back. To add to that, they already sit on a large base of merchants and don’t have to spend extra money on customer acquisition for their lending business. There are a long list of challenges which I have skipped so as to keep this short, but if you’re keen to know more, I’d be happy to share more!

This essay is a part of my 30 day writing challenge. You can read more about why I’m doing it here

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