This is a guest post from Jorrit Koop (Co-founder of First Circle), a collaborator for this special section.
An outward-in perspective of Tech-Lending in Latam
Latin America is a fantastic market for financial innovation. From the outside, it is often seen as a gathering of unpredictable and unstable markets, but it is exactly these facets that created a great environment for technology-driven changes in the financial sector. In this post, I will analyse the state of the market and outlook for tech lenders: the companies that use technology to lend capital to consumers and companies in a better way, several of which have made the news over the last months and years.
The firm I co-founded in Asia is called First Circle and has focused on providing smaller-sized, short-term working capital loans to SME’s. In Asia, just like in many markets in Latin America, banks are not able to serve this segment profitably due to 1) high processing- and overhead costs and 2) difficulties in assessing credit risk.
Our philosophy has always been that SME financing is and will remain very much a relationship business. This is the case even though technology can, will and should solve these issues of lengthy and expensive origination processes and credit risk. So, we have specialised in distributing our loans through intermediaries that our target customer group of SME’s already has trusted relationships with. E-commerce platforms are the best example of this; for example in Asia we are working with Lazada (now part of Alibaba) and Zalora (the Asian version of Dafiti) to lend to their merchant base.
E-commerce penetration in Latin America is high compared to the other three large emerging markets of Asia, Africa and Eastern-Europe. Especially in markets such as Argentina, where online buyer penetration is now around 60% and still growing rapidly, resulting in vast volumes of e-commerce trade flows.
In addition, SME’s in Latin America have always had significant trouble financing themselves with short-term capital; due to perceived macroeconomic instability and absence of overall GDP growth (and hence limited influx of foreign capital), average interest rates (for SME’s with access to bank financing) are around 30-40% per year, creating an SME credit gap of more than US$600 Bn, which is larger than the gap in the whole of Asia-Pacific (ex China) for example.
These factors combined mean a massive opportunity for firms that are able to deal better with risks and processes than traditional lenders currently do. For these reasons, we decided to expand to Latin America and roll out our business in Argentina first. Having operated here for several months now, a number of immediate observations come to mind.
First, local talent levels are very high. Compared to markets in Asia, it is easy to build a strong team, and build and run local operations. This is the result of a history of good schooling and cultural factors that have always been present in the region.
Second, it has historically been difficult for local founding teams of tech-lending and other FinTech startups to raise funds. This has led to only very few companies being properly capitalised, hindering growth and development of the sector in general. This also constitutes a large opportunity for foreign entrants. Mexico is a good example of what could happen to Latin American markets when VC money gets more abundant, with a large number of local startups now generating traction.
Third, the economic outlook has a very different effect on how attractive of a place Latin America, and each country by itself, is for tech lenders. Economic fundamentals purely measured by growth are less strong than in Asia, regardless of recent political changes that took place in some of the largest markets of the continent. Even though in Latin America, there is no tailwind of around 5% annual economic growth, the absence of it has led to huge scarcity in capital. Also in countries with moderate inflation, this has led to very high interest rates which has tremendously helped lending startups running young portfolios be profitable and charge 100%+ APRs. It is on the back of this development that Nubank in Brazil for example has been able to raise a large chunk of debt earlier this year. The point is that if the business model itself can prevent loan defaults, a volatile and stagnant economy in fact can be beneficial to tech lenders.
Bottom line, tech lenders that have shown to be able to 1) tap into (cheaper) forms of international funding and 2) have business models that can keep default rates low also in downturns and 3) can look through market realities and will win in Latin America.
About Jorrit Koop
Jorrit is co-founder of First Circle, where he currently serves as CEO of Latin America and was Group CFO. Prior to that, Jorrit was Managing Director at the CompareAsia Group and investment banker at Morgan Stanley in London and Dubai. Jorrit is member of the Global Shaper community of the World Economic Forum, and has a MA in Finance from the University of Sankt Gallen in Switzerland.