Around 1.7 billion people globally are still unbanked – either having no proper savings or access to credit - according to the 2017 Global Findex Database. In Southeast Asia, only 27% of adults have formal bank accounts and only 33% of businesses have access to proper financing. While the region has been growing exponentially for the past few decades, financial inclusion in the region remains poor.
The Philippine economy in particular has been consistently growing by 5.3% per year, driven by favourable economic conditions and strong macroeconomic fundamentals. However, this promising growth can only be achieved sustainably and inclusively if roadblocks currently faced by the lifeblood of the country’s economy - its small and medium-sized enterprises (SMEs) - are addressed.
Although SMEs comprise 99.6% of all businesses in the Philippines and employ 65% of the workforce, they only account for 35% of the country’s gross domestic product (GDP). Clearly, there is much room for development in this sector that could unlock opportunities for greater employment, rising incomes, innovation and value creation.
Lack of access to business credit
Among the host of challenges faced by SMEs, the most notable is a lack of access to credit. In Southeast Asia, 33% of SMEs lack access to loans and a line of credit. This problem is more acute in the Philippines, where a staggering 50% of SMEs do not have access to formal loans.
This problem prevents SMEs from doing as much business as they possibly can. Cash flow gaps faced by suppliers of big corporations and government agencies, for example, are huge blockers that limit their growth potential, and small business owners often have to turn down business opportunities that come their way due to a lack of the capital necessary to take them on. This is mainly brought about thanks to large buyers having the upper hand in negotiations and extending payment terms to their smaller suppliers for as long as they possibly can - which leaves small business owners waiting for payment for months, and sometimes even years.
And as business expenses pile up while payments from large buyers fail to materialise, the desperate need for capital arises. To solve this problem, small business owners often use their own personal funds or borrow from family and friends. Even worse, they turn to predatory and informal lenders who charge interest rates ranging from 10-50% of the loan amount per transaction.
With most banks requiring large bank deposits and real estate property as collateral before extending credit, it is no surprise that SMEs lack proper alternatives - not to mention the slow underwriting processes caused by a lack of available credit information, and a lack of bank and government guidance on compliance documents.
Innovation in underwriting SME loans
A lack of previous credit history creates a vicious cycle for SMEs. Loan applications with missing information are automatically rejected by formal institutions, which leads SMEs to again go back to informal sources of funding.
To solve this problem, the question that needs to be tackled is: how can underwriting of SME loans be simplified, given the lack of data on small businesses that have no history of transacting with formal institutions?
The Philippine government has been proactively seeking solutions to improve credit scoring capabilities within the country. Enacted in 2008, the Credit Information Corporation (CIC) was tasked with collating and distributing relevant information with which to create a complete credit report for borrowers. CIC Credit Reports will generate credit scores which will assist lenders and borrowers alike, resulting in a higher rate of successful transactions, lower transaction costs and improved transparency between lender and borrower.
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Mixing non-traditional and traditional data points for credit scoring, fintech innovation has been able to create a reliable alternative credit score for previously unbanked individuals. Fintech startups supported by the Philippine government, such as First Circle, are taking on the challenge of servicing businesses that do not have any prior credit history by using available information sources such as social media and network and cellphone data, as well as building their own database on supply chain networks, in order to determine the feasibility of a loan. This enables these startups to create their own risk scores for transactions presented to them by small businesses, and to prove their creditworthiness despite the lack of traditional credit data.
In parallel, notable fintech companies like Lenddo and Ayannah are spearheading the use of big data to create a comprehensive credit scoring system for individual consumers. Mixing non-traditional and traditional data points for credit scoring, fintech companies are even able to create a reliable credit score for previously unbanked individuals.
Fintech companies in Southeast Asia have been making great strides in improving access to financial services for millions of individuals and business entities by shaking up the traditional approaches to credit scoring. With innovative technology beginning to pave the way for the creative use of alternative data, the challenge of accelerating growth for the region’s unbanked and underbanked population in the region is finally being addressed.
Written with Patricia Canaveral and Anton Carlos.