Risks and Benefits of Fintech
Currently, we are witnessing the expansion of financial technology (fintech) services as a form of disruptive innovation that may disturb conventional industries, such as banking. What are the risks and benefits of fintech? Will the fintech industry fight potential risks and secure its future?
In the span of only two years, the fintech industry has bloomed significantly. The industry has gone from managing US$12.05 billion (Rp 161 trillion) in 2015 to $18.64 billion (Rp 249 trillion) this year. The industry provides many services, including payment, funding and peer-to-peer loans. Projections are saying that the Indonesian fintech industry will account for $22.7 billion (Rp 303 trillion) in 2018, $27.24 billion (Rp 364 trillion) in 2019, $21.98 billion (Rp 427 trillion) in 2020 and US$36.61 billion (Rp 489 trillion) in 2021 (Kompas).
Surely this is huge funding potential for startup businesses. Just compare it to the growth of banking credit, which reached Rp 2.904 trillion in December 2015 and Rp 4.2 trillion in December 2016.
Fintech business offers loan models, such as peer-to-peer lending and crowdfunding. Peer-to-peer lending is a digital financial service that helps loan seekers and potential funders find one another. Crowdfunding is a funding mechanism based on a mutual assistance principle or raising monetary contributions from a large number of people.
Such loan models without the need for collaterals have huge potential for debtors who are, say, micro, small and medium enterprises (MSME) – a majority of which are unable to access funding opportunities from banks. This is the main benefit of fintech.
A Ministry of Cooperatives and Small and Medium Enterprises 2013 data shows that Indonesia has 57.89 million MSMEs, comprising 57.19 million micro enterprises, 654,220 small businesses and 52.11 million medium enterprises. Micro businesses dominate contributions to Indonesia’s gross domestic product (GDP) at 60.34 percent, followed by small businesses’ 36.9 percent and medium businesses’ 13.72 percent.
Furthermore, MSMEs can absorb over 100 million workers – 114.14 million, to be exact – comprising 104.62 million in micro enterprises, 5.57 million in small enterprises and 3.95 million in medium enterprises. Thus far, the MSME sector has proven its resilience through financial crises, such as the one in 1997 and 1998. A major factor in this resilience is MSMEs’ lack of dependence on foreign currencies.
Risks and their antidotes
In order to fight potential risks, Bank Indonesia (BI) issued its ruling No. 18/40/BI/2016 on Payment Transaction Processing Management on November 8, 2016. BI also established the BI Fintech Office and the Regulatory Sandbox. The Fintech Office is a place to find information, mitigate risks and evaluate the business model of fintech services. The Regulatory Sandbox in a limited-environment laboratory used by business players to test out innovative products and business models.
The Financial Services Authority (OJK) launched OJK Regulation No. 77/POJK.01/2016 on Information Technology-Based Money Lending Services on December 28, 2016. Despite this careful regulation of the fintech business by both BI and OJK, potential risks are still lurking and can bubble up to the surface at any moment.
The first risk is related to the “Five Cs” formula. Fintech businesses rely heavily on information technology and, as such, face-to-face meetings between funders and loan seekers are not necessary. This is in stark contrast with banking, which prioritizes the “Five Cs”, of which the first is character. Lenders need to assess the character of loan seekers to be assured of their goodwill in paying back their loans. The second C is capacity, as in the loan seekers’ capacity to pay back their loans based on their ability to run their business.
The third C is capital, which refers to the loan seekers’ ability to effectively use the loans, and the fourth C is collateral, or how good the collateral is in covering the loans’ potential risks. The last C is condition, or assessing business prospects in current and future conditions. In order to dig into these Five Cs, it is necessary for funders to have face-to-face meetings with loan seekers.
Can we sufficiently cover this formula only through forms filled in by loan seekers as electronic information? This is enough to find out the loan seekers’ personal information but surely is not adequate to really understand their character. Perhaps this is not really an issue right now as credit with mid-term tenors has not yet reached the deadlines.
To put it bluntly, a face-to-face interview is an effective way to dig deep into loan seekers’ character. The fintech business model should adhere to the compliance principle that banks have adhered to for so long.
The second risk is OJK’s approval of fintech business’ use of electronic signatures, which is a signature comprising attached electronic information, associated or related to other electronic information that serves as a verifier or authenticator, as stipulated by Law No. 11/2008 on Electronic Information and Transactions.
Thus far, conventional and sharia banks have never used electronic signatures. They still rely on real signatures. If you open a new bank account, you are required to sign your new account book. This is an instrument for the banks to verify banking transactions.
Therefore, fintech business players must implement reliable and secure electronic certificates, which contain electronic signatures and an identity of the legal subject status of the parties involved in the electronic transactions.
Third, information technology also brings with it various forms of operational risks, be it in human resources, processes or technology (Michel Crouhy, Dan Galai & Robert Mark, 2000).
There is a high risk of system failure in information technology. This can create errors in financial records and payments. Just imagine a system error that adds another zero to transactions, resulting in Rp 1 million becoming Rp 10 million, Rp 10 million becoming Rp 100 million and so on. In short, system errors or failures will result in financial damage.
In clearer language, fintech business players must implement a system of operations with a high level of security and reliability, in line with the BI and OJK regulations as well as Law No. 11/2008 on Electronic Information and Transactions. In order to resolve system failures, fintech business players must have contingency plans and apply a risk management scheme that covers credit, operational, market and liquidity risks.
Consumer protection
Fourth, fintech business players must also prioritize consumer protection. The relationship between consumers and investors must be equal to ensure consumers’ rights of secrecy (of personal, financial and transactional information) and to provide them a space to report any problem. It is common knowledge that loan seekers’ data is sometimes given to other parties without their consent. Fintech business players must uphold consumers’ rights.
Fifth, fintech business players must implement programs to fight money laundering and terror act funding as stipulated by the law. This is closely linked to the total amount of funds managed by fintech businesses, which reached $18.64 billion (Rp 249 trillion) in 2017. This is a considerable amount for the current small-scale fintech business.
This is related to the mushrooming of fake investment schemes under the pretense of cooperatives or investment programs. Perhaps such schemes are nowadays used for money laundering (Paul Sutaryono, Kompas). In order to avoid such risks, fintech business players must implement know-your-customer (KYC) principles. The circulation of money, from the investors’ source of funds to the loan seekers’ fund usage plan, must continuously be monitored.
Sixth, we have to continuously monitor all fintech business transactions, including an audit on information technology. Human resources audits are also important because the people behind the technology are also a risk, much like the information technology itself.
By implementing anticipatory measures for potential risks, the fintech business is expected to contribute to funding MSME loan seekers. Fintech can also improve financial inclusion rate, which was at 67.82 percent in 2016. This is to say that, out of 100 Indonesians, only 68 have access to financial services and products.
PAUL SUTARYONO
Banking observer and former BNI Vice President