Credit fintech companies that cater to the financing needs of small- and medium-sized businesses in Asia are likely to consolidate, with the strongest players poised to grow market share – and executives at those firms expecting the weaker players to fold.
The main culprit is the new environment of higher interest rates. The impact of the Federal Reserve hiking rates has been uneven across Asia. Singapore and Hong Kong have had to raise rates in tandem, while other markets are less directly exposed to the US economy, and have been able to moderate rate increases, or even in some cases, such as Vietnam, cut them.
Nonetheless the overall trend has made money and credit more expensive, with interest rates increasing across Southeast Asian markets in aggregate by 300 basis points over the last 12 months, says Nikhilesh Goel, co-founder and CEO of Validus, a Singapore-based SME lending platform.
SMEs have borne the brunt of this. Small businesses are always sensitive to delays in cash receivables, and under pressure to make payroll or pay their own bills. Some can convince banks to offer them credit lines, usually because they can prove they are part of a multinational’s supply chain. But in emerging markets, many lack the credit bureaus or other formal judges of creditworthiness.
But paperwork is only part of the challenge: banks are unwilling to lend to most SMEs in developed markets such as Singapore and Hong Kong as well. The unit costs of serving small, risky customers is too high.
What fintechs provide
Fintech companies have stepped in over the past decade to help SMEs with working-capital solutions. They provide digital platforms, using data-intense, AI-driven credit assessment to determine an SME’s health. They purchase different types of short-term assets of the SME, such as invoice receivables, for 80 or 90 cents on the dollar. The SME gets cash right away.
The fintech, in turn, packages those short-term promises into an income stream that it can offer investors who provide the financing. Those suppliers of capital might be banks, or institutional or individual investors.
Higher interest rates are the Fed’s way of tightening credit conditions to manage an overheating economy. Getting banks to pull back from lending is the point, and it has been working – to the detriment of SMEs, which are more vulnerable than big companies to a credit squeeze. Their businesses slow and they get paid by customers later.
“Credit fintech has been an important product for SMEs, especially now that credit is drying up and banks have become cautious,” said Tzu-Chung (TC) Liang, Southeast Asia financial services strategy and transaction leader at EY in Singapore. “The customer’s pain point has only gotten worse, so the need for fintech lending is there.”
But higher rates complicate things for fintechs.
Higher rates, higher risk premia
Until last year, fintechs offered investors yields of 6 percent to 9 percent, depending on the underlying credit. That was an attractive return in a world of zero interest rates.
Since mid 2022, the Fed has hiked overnight lending rates from 0.25 percent to 5.25 percent, but fintechs can’t simply match increase that in their pricing.
“Interest rates are high, but risk premiums are higher,” said Vittorio De Angelis, co-founder of Velotrade, a Hong Kong fintech focused on trade finance. The premium reflects what investors expect to get paid to take additional risk. When interest rates are low, investors are eager for yield. When interest rates go up, investors can get paid by parking money in low-risk bonds or money markets.
“If rates rise by 5 percent, it’s not enough to give investors 5 percent extra,” De Angelis said. “They will demand a greater risk premium.”
This puts fintechs in a bind, however. Since late 2022, their real cost of funding has gone up, meaning their cut for serving as an intermediary is smaller.
“It’s hard to increase pricing, because if you make the SMEs pay more, some of them will go out of business,” said Kelvin Teo, Singapore-based co-founder of Funding Societies.
Climbing the quality curve
This is the dynamic that is forcing consolidation in the fintech space. Those with razor-thin margins and low-quality SMEs (which are more likely to default) are now acquisition targets, or might simply disappear.
But this is also the moment when the strongest credit fintechs will assert their dominance. They are doing so by upgrading the quality of SMEs on their platforms.
They are poaching top-tier SMEs, embedded in global supply chains, which have been cut loose by risk-averse banks. Fintechs are also scrutinizing the borrowers on their platforms, to look at how those SMEs are getting paid – who owes them money? If they are awaiting payment from listed companies with a credit rating, or with assets that are secured with collateral, then those small businesses are in good shape, even if the payments are delayed, and fintechs want them on the platform.
Going up the credit curve is useful to mitigate the risk of a loss. The fintech has purchased that SME’s receivables, and if the SME doesn’t get paid, then the fintech suffers that loss.
“This is a third-party transaction between the SME and its customers,” Liang said. “The fintech is here to provide credit scoring.”
Improving credit quality also appeals more to investors. In an environment of high interest rates and high risk premia, investors want quality assets, not high yield. So the quality of the underlying invoices is more important. This also makes it easier for the fintech to maintain its margins, by spreading the higher costs evenly among SMEs and investors.
Winners take most
Only a handful of SME lenders can move up the quality curve. Size and breadth help. Funding Societies operates in five markets, Validus in four. Conditions may be stormy in one market but balmy in another. Domestic investors in Malaysia or Indonesia aren’t exposed to US capital markets and they aren’t putting all their money into US money markets; a single-digit yield is still attractive.
Even for global institutional investors, Asian SME fintech has some appeal. It’s not correlated to bond markets. Investors lost their appetite for risk because the hike in rates caused the value of bonds to fall. But SME financing pools weren’t impacted. “We’re not a mark-to-market asset class,” said Teo.
That high risk premium is also abating. Eventually the world adjusts to the new environment of higher interest rates. Costs get passed to the ultimate consumer. Corporations will have more certainty and resume paying their suppliers on time.
Fintechs with the highest-quality SMEs, the best AI-driven credit scoring, diversified markets, and strong investor pools are well positioned. The macro shock scattered the banks. It also prevented superapps and digital banks from entering the space.
“During the frothy days of startup funding, it seemed like every startup stived to get into the lending game,” said Goel at Validus. “Now we see everyone realizing that lending requires specific skillsets and expertise.”
For the leaders in the space, the past 12 months were about surviving. The next 12 months could be about thriving.
Teo said, “It’s time for consolidation, which means winning the entire category of SME credit in Southeast Asia.”
