Why P2P lending can be the game changer for SMEs- Perspectives from Latin America
By Mercedes Aguirre & Sandra Garcia-Rivadulla
When we look into platform economies that are disruptive and hold the potential for deep socio-cultural changes, we feel compelled to look into microfinance, more specifically the notion of Peer to Peer lending (P2PL) (also known as social lending). P2P-based platforms are mostly aimed at those constrained by socio-economic factors or even time, and try to fill in the gap left unattended by traditional financial institutions. Rather than acting as a financial intermediary, P2P lending platforms offer mathematical algorithms that measure the potential borrower’s risk and provide this information to possible lenders that will determine the amount, rate and specific aspects of the loan, for the individuals they will be funding. These platforms can take significantly less time (sometimes as little as a few minutes) with assessments as borrowers provide all their personal data and financial needs upfront.
There is a substantial portion of the population, especially in developing countries, which lack access to traditional finance systems. Credit rates are either too high or completely unattainable, a good score is a must and bureaucratic processes often take too long, preventing borrowers from obtaining funding. This is often the case for small enterprises, start-up entrepreneurs or low income individuals. This issue is not only relevant from an individual standpoint but more so when looking at society as a whole, where the empowerment of low-income individuals and small and medium enterprises (SMEs) can revitalize the country´s economy to a great extent. This also allows for what is known as the “Distribution Power Law”, where platform business models are able to access the “long tail” of the population distribution curve comprising users or customers not being reached by more traditional means.
In developing economies, the International Finance Corporation found limited access to finance as the second most significant obstacle for small business, currently affecting a labor force of 500 million people.1 Overall, under-developed capital markets lead to sub-optimal levels of investments, most of them being allocated to real estate and traditional banking savings. With the advancement of alternative platforms, P2P and crowdfunding can be optimized to reach SMEs as well as other unattended sectors of the population.2 These, among other aspects of emerging economies, are key to the continuous development of the P2P lending market.
In Latin America, P2P-based platforms have gained momentum during the last few years, but still struggle with headwinds stemming from an uninformed population and vague regulatory frameworks. Overall, the alternative finance market poses a substantial set of challenges in terms of regulatory risk and oversight. Several business aspects stand to be affected by new or changing regulatory frameworks such as consumer protection, investment assets, capital requirements, data and privacy management among others.3 In this sense, the possibility to build a regulatory framework that grants guarantees to market players and consumers but at the same time does not fail to enable the industry’s advance and development will be key for a fast-growing market.
The accelerated growth of this market is already well documented by Ziegler et.al. (2017), where the authors found that the Latin American and Caribbean market closed 2016 with a total value of USD 342.1 million. This sets an impressive growth record from the USD 110.6 million observed in 2015. Among the alternative finance models considered in the study, P2PL – especially P2P business lending – stands out with more than 30% of the region’s total market value. The second most relevant structure within Latin America and the Caribbean was Balance Sheet Lending, where the platform acts as counterpart for individual lenders assuming all the credit risk, hence working under a structure more similar to that of traditional banking.4
As stated, loan-based alternative financing is the driving force behind Latin America and Caribbean online alternative financing. This implies that policy makers should track the dynamics and development of these markets when creating a regulatory framework aimed at minimizing potential risks while fostering growth, fairness and efficiency. While there are current jurisdictions where some aspects of alternative online financing have been already addressed, others have frameworks that leave the market in a complete legal vacuum, or no frameworks at all. Fortunately, there is a growing number of countries in the region that are actively addressing this issue aimed at reducing or eliminating regulatory gaps. Examples include Mexico and Brazil which have already set regulations addressing this market, while Uruguay, for instance, is working on the development of a proposed framework that is currently being analyzed both by market players and the government. On the other hand, there are countries where the market is still unregulated or where authorities have explicitly stated that no specific regulation is expected to be developed, such as in the case of Argentina.
All in all, much has been done since the region has gotten caught up in this new trend, but there is still a long way to go to reach the point of market and regulatory stability. Although many countries, local and international institutions, such as the International Development Bank, have joined efforts to help the market strive and develop in a healthy way, we are still most likely set for a bumpy ride.