Understanding The Diversification

The first port of calling for lenders were sellers on e-commerce sites.

Traditionally, banks have shied away from lending to small and medium enterprises (SMEs) due to the dearth of reliable data on this segment, meaning they were not able to assess credit-worthiness definitively.

But the steady stream of data on e-commerce sellers makes it a safe bet as it gives lenders predictable insights on their operations.

What Is The Accessible Data?

In addition to ordinarily accessible data like balance sheet and income tax returns, fintech lenders could also get a peek into data provided by the retailers—like the volume of sales, what percent of goods sold by that seller was returned, the reviews of the products sold. All this helps lending startups build a solid credit risk model. The segment is also more profitable because customer acquisition and operation costs are low.

Naturally, everyone wanted to lend to this emerging and fast-growing group.

Even banks.

And because no one can compete with banks on offering the best lending rates, the best e-commerce sellers gravitated towards them, swayed in no part by their rates that were a few percentage points lower than those of the leading startups.

The smaller and in many cases the more dubious ones had no option but to approach newer fintech lenders, leading to an adverse selection problem. With the passage of time, this inevitably led to defaults, especially with platforms of troubled brands like Snapdeal.

Now, with both Flipkart and Amazon entering the fray themselves, the chances of fintech lenders winning e-commerce sellers as customers have further dwindled.

Lending companies typically lend at 18-20% interest rates to SMEs, using capital that typically costs them 10-12% to raise. Banks, in contrast, have nearly half that cost, at 6-8%, allowing them to offer lower interest rates to borrowers too.

Given their size and balance sheets, Amazon and Flipkart too would be able to raise funds at the same rate as banks, which is 6-8%, giving them the ability to price loans at the same rate as banks. On the costs side, the two would already have mandatory “Know Your Customer” (KYC) details of their sellers, since they’re a prerequisite to bringing them on board. They would have near-zero costs associated with customer acquisition, as they already own the data to identify which seller to finance.

Lastly, there’s the biggest headache for any lender, be it online or offline—the collection of loans extended. Since e-commerce platforms control the monthly payment to their vendors, repayments can be as simple as withholding part of it.

To be sure, Flipkart and Amazon already partner with banks, NBFCs, and fintech lending startups to extend loans to their sellers as well as finance their customers’ purchases. But only a fraction is given credit because banks and NBFCs are still experimenting with it. Data on credit, repeat purchases, and repayments are still thin. But once they achieve the ability to lend themselves, it becomes a lever they can use to grow their businesses.

The Only Way Out

There’s only one way out of this squeeze for lending startups. It starts with “D” and ends with “-fication”.

Today, Capital Float lends to a variety of SMEs moored to digital platforms, like travel agents and cab drivers. They also lend to brick and mortar SMEs like local grocery stores (kiranas) and manufacturing units. Unfortunately, that means trawling through millions of SMEs whose credit-worthiness is doubtful and will need to be evaluated from scratch.

Sure, one can argue that the SME segment is a large one. An almost Rs 50,000 crore opportunity, according to rating agency Crisil. But finding those who are credit-worthy within this will mean lending startups will have to venture into the territory of traditional NBFCs by employing large sales forces, which can increase their costs dramatically.

Acquiring and servicing these customers is a costly affair. It costs about 30% more to service SMEs that are offline, says the banking official quoted above. That’s because if you want to lend to Kirana stores or small manufacturing units, you need a sales force to identify the right candidates.