High demand and profits drive peer-to-peer lending in Indonesia

Peer-to-peer (P2P) lending in Indonesia recorded triple-digit growth in 2018 as a large unbanked population embraced sub-prime micro-lending services to meet a credit shortfall estimated at $75bn. P2P loans offer significantly higher returns to private investors, while government data shows that defaults are rare, leaving the segment well positioned for growth; however, a rising incidence of predatory lending practices has dampened the outlook somewhat.

Recent Growth

The P2P industry has undergone significant growth since December 2016, when the Financial Services Authority (OJK) introduced the country’s first P2P lending regulation for IT-based lending services. This introduced new guidelines, obligations and restrictions regarding P2P lending, including a requirement that lenders be registered as Indonesian limited liability companies or as Indonesian service cooperatives.

The regulation set a foreign ownership cap of 85% – against 49% for e-payment platforms – while P2P providers are also required to undergo a two-stage process of registration and licensing, as well as hold at least Rp1bn ($71m) in paid-up capital when registering with the OJK. By December 2018, 88 financial technology operators had obtained licences: 78 of these were existing players that were required to register with the OJK by June 2017, in addition to 10 new players. Lending has since soared, with the OJK reporting Rp16trn ($1.1bn) in loans to 2.8m borrowers between December 2016 and October 2018. Loans distributed through P2P platforms increased by nearly 800% in 2018, from Rp2.6trn ($184.4m) to Rp22.7trn ($1.6bn). While P2P lending still composes just a fraction of total bank credit, its growth is easily outstripping formal lending, which averaged 8-10% per annum between 2014 and the first half of 2018.

Risk & Return

Banks’ reluctance to offer subprime consumer and micro-lending services has created new opportunities for financial technology (fintech) start-ups to enter the segment. P2P lender Bank Tabungan Pensiunan Nasional Syariah, for example, generally offers one-year loans of between Rp1m ($71) and Rp2m ($142) at a flat interest rate of 30%. This is equivalent to a 51% effective annual rate, compared to traditional banks’ net interest margin of 5.1%. P2P defaults are also low, with the OJK reporting that some 3.3% of loans were considered questionable as of September 2018. Private sector interest in P2P services is on the rise as a result, as evidenced by ride-hailing and payment platform GOJEK’s announcement in September 2018 that it had partnered with P2P lenders Findaya, Dana Cita and Aktivaku to grow its ecosystem.

Financial Inclusion

P2P lending in Indonesia has recorded such significant expansion in large part because it meets a growing demand for credit in a country where 51% of the population remains unbanked. P2P platforms are attractive across the country because they do not require providers to establish a physical presence in several locations across the vast archipelagic country to disperse funds. Nonetheless, a large majority of P2P borrowers currently reside in Java, the most populous and prosperous island in the country, which accounted for 86% of all borrowers as of September 2018.

As well as providing personal loans, P2P platforms also fill the gap for micro, small and medium-sized enterprises (MSMEs) seeking trade finance and inventory loans, and have become a prominent source of agriculture finance for small-scale farmers and other agri-businesses. “Most micro-enterprises lack access to credit, as traditional banks are designed to help larger businesses,” Reynold Wijaya, CEO of Modalku, told OBG. “But lending also requires a lot of customer education as a lack of financial literacy and fraud constitute the biggest drivers of default.” P2P platforms are able to mitigate risk to some extent by using big data tools to analyse the credit-worthiness of low-income clients and MSMEs, with some microlenders exploring the possibility of using personal and publicly available information such as call data patterns, social media activity and location data to build a risk profile. However, the segment’s potential to expand financial inclusion further is still constrained by a lack of digital knowyour-customer (KYC) mechanisms. This dearth of available credit information on individual micro-borrowers, as well as the common consumer practice of taking out multiple loans with different lenders, have raised questions about the medium and long-term sustainability of P2P lending’s growth trajectory.

Providing P2P lenders with access to the official digital ID database of the Population and Civil Registry Agency (DUKCAPIL) could go some way to mitigating these problems, while the eventual integration of DUKCAPIL data with facial recognition technology could see a seismic shift in the capacity of P2P to serve low-income clients. The Fintech Association of Indonesia (AFTECH) held discussions with DUKCAPIL in late 2018 about the possibility of fintech firms gaining access to their data. “Of the unbanked population, the greatest barrier to access financial services is the physical distance to a branch. Having said that, 69% of the unbanked own a mobile phone. Digital infrastructure and remote KYC technology can be leveraged to overcome this hurdle, and become a catalyst to driving financial inclusion,” Niki Luhur, chairman of AFTECH, told OBG. “There have been several regulatory hurdles to overcome to enable digital identity infrastructure to be accessed by fintech firms, but now most of the groundwork is in place and there is tremendous potential to leverage digital identification to be used for KYC, which would also benefit commerce, education, and health care.”

Predatory Lenders

Although the industry has flourished, it also faces serious challenges on the supply side. “Driving financial inclusion through digitalisation continues to be of paramount importance,” Dev Dhiman, managing director of Experian’s Southeast Asia and Emerging Markets, told OBG. “In an environment where people in rural areas turn to informal lending, which typically causes a vicious debt cycle, there should be more efforts to offer fair access to formal credit through alternative data.“ In 2018 the OJK announced it was collaborating with the Ministry of Communication and Information Technology to block over 400 websites and mobile applications purportedly offering illegal and predatory P2P lending. Warnings were also issued to 78 P2P lenders, threatening to revoke or suspend licences.

The OJK itself has received more than 2000 similar complaints, including of intimidation and sexual harassment during debt collection processes, breaches of data privacy and failure to record loan payments, leading to inflated interest charges and borrowing costs. Although the OJK is actively clamping down on predatory lenders, the scale of the challenge is significant. The authority reported in mid-February 2019 that a further 231 illegal P2P lenders had been found to be operating in Indonesia since the turn of the year, with many advertising their services through popular social media sites. “A lot of companies are making mistakes and employing predatory practices. Debt collectors are aggressive to the point of intimidating people out of their villages and breaking up communities. The social issues that emerge as a result of the abuse of new technologies need to be addressed,” Lishia Erza, chief commercial officer at Asyx Indonesia, a financial services firm, told OBG.

Code of Conduct

The OJK and registered P2P players are taking steps to address these matters. The Indonesian Fintech Lender Association is now collaborating with the OJK, the National Police and the Investment Alert Task Force, among others, to create a new code of conduct for P2P lenders in an effort to enforce industry standards and best practices. This should allow the authorities to eliminate bad actors from the P2P landscape, helping the segment maintain a strong growth trajectory in 2019.