Cover Story / April 2018

Empowering Small and Medium Businesses

By Eko Prasetyo

Many of the more than 260 million people in Indonesia are still considered non-bankable and do not qualify for bank credit, despite living in a country with a rapidly expanding small-business sector.

Modalku, a peer-to-peer lending financial technology platform established in January 2016, aims to fill this gap and it is on a mission to become the online marketplace of choice where small entrepreneurs can obtain loans.

GlobeAsia recently spoke with Reynold Wijaya, chief executive and co-founder of Modalku, at his new offices in West Jakarta. He talked about the company's mission and achievements as a leading P2P lender in Southeast Asia and how financial technology can be a solution for small and medium enterprises.

"Modalku is a platform that connects borrowers who need working capital with lenders who have extra money and want to get interesting yields. In this case, Modalku's interest rate may go up to 30 percent, but on average, the lenders may expect up to 15 percent with good diversification," the Harvard Business School graduate said, adding that the company is currently registered with the Financial Services Authority (OJK).

However, Modalku's business model was not created in Indonesia, as Reynold and his business partner Kelvin Teo, whom he met during his studies, first implemented it at the startup Funding Societies in Singapore in 2015.

Funding Societies enabled SMEs to seek funding for their business expansion from a pool of investors through crowdfunding. With a standard loan period of between three months and two years, small businesses may borrow up to S$500,000 ($380,000).

But when it came to Indonesia, Reynold realized that there was a staggering gap between supply and demand. Modalku was established with the sole purpose of scaling up non-bankable Indonesians by pooling investors to give such borrowers their first SME loans to help them create bankable credit histories for themselves.

"In Indonesia, we usually have a crowdfunding round for 10 days, but the target amount would be filled within only two or three days. Around 90 percent of borrowers complete their rounds within three days," he said.

"There has never been a case where we have failed to crowdfund. The borrowers' success rate is also reflected in the nonperforming loans, which currently stand at 0.8 percent."

There is a surprisingly small number of nonperforming loans, considering that Modalku is active in a high-risk segment involving newly established startups, which means interest rates are generally higher to compensate lenders for their risks.

"We do not take anything from the spread, as we only impose fees," he said. "In short, we can tolerate more defaults. In comparison with banks, which mostly have 3 percent to 5 percent in nonperforming loans, I hope it would be below 2 percent or 3 percent for Modalku this year."

Realizing that technology is the future of finance, Reynold and Kelvin decided to become part of the revolution. For both of them, it is no longer about personal gain, but helping others.

"We initially agreed that if we want to start a business, first would be to do it in our home countries. Secondly, it had to be meaningful – not in a sense that we are trying to be saints, but if it were only about financing ourselves, we would rather have stayed where we were," Reynold said, adding that he considers himself an underdog in the business.

"We believe SMEs are our fellow 'underdogs' that need access, and we are giving them access so they can grow bigger," he said.

Regulations, Security and Fraud

Even before starting Modalku, Reynold met with the OJK to allow smooth sailing for his company, after taking lessons from Funding Societies in Singapore, a financial hub with more advanced regulations.

"We realized from day zero that finance is the most regulated sector in the world, which is why we needed to be very compliant from day zero," he said.

"We believe that having the OJK on our side was very important. If not, it would be impossible, since this business was something very new at the time.

"We are creating something from nothing, which is why we needed the regulator's support. They were very open and supportive. The OJK has been amazing, and I hope their support would become bigger in 2018."

Compliance with regulations is also nothing without data security, as it might lead to various issues, including fraud. Reynold said the company recently received its ISO 27001 certification for information security management, but he added that there are no guarantees when it comes to data security.

"Again, there is no such thing as 'bulletproof.' But the fact that we already got our certification proves that we do take the outmost care with our customer's data," he said.

He went on to explain that Modalku uses technology to detect fraud, although it would not be able to replace credit bureaus when it comes to storing the financial histories of clients, which is necessary for them to become bankable.

"Fraud is the single biggest reason for default in Indonesia, or the scariest thing by far. This is where technology comes into play," he said. "Many of our customers do not have loan histories. Technology in a sense, is very good at detecting fraud, such as by triangulation of location, tracking, social media or mobile data."

Modalku applies data verification through profile screening, anti-fraud verification, psychometric testing and more. Profile screening involves an automated process, with customers being required to pass three layers of verification: providing a photo of themselves, uploading copies of their identity cards and submitting details of their social-media accounts.

"We will check all three automatically and through machine learning we can identify whether the provided information all came from the same person. Are these bulletproof? They are surely not. But these are some of the things we do, in addition to other fraud-prevention mechanisms, to prevent fraud," he said.

Scaling for Growth in Southeast Asia

Modalku was recently named the leading P2P lending startup in Southeast Asia. When asked about this achievement, Reynold said they have built Modalku and Funding Societies for the region and developed from there.

"The most important thing for us is not being the first, but the best," Reynold said. "But we happened to also be the first in the region. I think it is important to be the first to comply with regulations, acquire the ISO, as well as being the first to have P2P licenses in three countries: Indonesia, Singapore and Malaysia."

This, in addition to being the first to implement an escrow account in cooperation with Bank Sinarmas as the custodian bank, has set high standards for competitors, he said.

"Finance is a business of trust, which is why we set a very high standard. We do not want to force people if they do not want to. We just want to show that we are good people trying to do good things for others," he said.

Reynold believes the industry will reach maturity within five to 10 years. However, Modalku is not competing with traditional banks, but working alongside them to meet the demand, which he says is much higher than supply in Indonesia.

"What we are trying to do is break the vicious cycle. When people go to the bank, the first thing they are asked is collateral. But if you do not get financing, you will not be able to grow. If you can never grow, how will you get assets to begin with?" he said.

Modalku tries to provide an alternative where the company may be able to identify non-bankable persons as good borrowers that lack collateral and provide them with reasonable interest rates to grow their businesses.

"It is not the cheapest rate, because it is not meant to be the cheapest. Why? Because the borrowers present greater risk compared with those that are bankable, as they have yet to gain credibility as borrowers."

And although Modalku's interest rates were not designed to be the lowest, they are still lower than those on non-collateral loans issued by banks, because such borrowers involve greater risk.

"But again, we do not have 300 percent to 500 percent interest rates, such as those imposed by some people," Reynold added. "I think our rates are very good, because we only take fixed fees for every transaction between borrowers and lenders."

Indonesian Market and Growth

Aside from providing a new business model, Reynold says the Indonesian market is a totally different animal compared with Singapore, where they already have a mature and well-developed financial sector.

"Our clients in Indonesia still need financing, as they cannot get it from the banks. Their only alternatives would be nothing at all, or maybe loan sharks," he said.

According to him, Modalku has grown tenfold in terms of fund disbursement, with the company having disbursed Rp 50 billion ($3.5 million) to Indonesians in 2016, which increased to Rp 450 billion last year. It aims to disburse trillions of rupiah this year.

However, this also creates another risk for borrowers and lenders. The company is making its best efforts to ensure that borrowers have the ability to generate incomes to repay their loans, and by doing so, the company has had to reject many applications due to borrowers' limitations.

"If you cannot pay, it is not good for you, nor the lenders," he said. "We do have negative portfolios, but there are definitely more positive ones as we try to diversify the funds. I personally handle over 700 loans per month, although these are the smaller ones," Reynold said, adding that lenders should be very careful not to put everything in one basket.

"If you ask me whether lenders should earn some money in return, I will answer you that they should, as it has been proven by hundreds of portfolios," he said.

He also addressed the issue of potential money laundering through this business model, which is possible if players do not comply with regulations.

"Like I said before, if bad people want to come in and ruin it, they can. But at the same time, if we comply with the regulations – with everything being done through banks with virtual accounts or escrow accounts, it would eliminate the possibilities," he said.

"This would only become an issue if the players do not follow the rules."