The personal loans market worldwide is huge. According to the Global Consumer Credit Market 2016-2020 report, the key players in the global consumer credit market are – BNP Paribas, Citigroup, HSBC, Industrial and Commercial Bank of China (ICBC), and JP Morgan Chase. The consumer credit market in the US alone has been estimated at $4 trillion.
The Market
If we look at the unsecured loan market, the number of people taking out such loans in Europe alone in 2015 was 13.72 million. (TransUnion). Another 24 million Americans will likely take a personal loan this year alone. (Bankrate). Such loans are often taken by people seeking to undertake a big upcoming expense but need more savings.
High margin business
Personal loans generally have a lock-in period of one to five years. Payments are auto-deducted from a checking account. It helps reduce the chances of a payment default. The rationale for taking these loans is sometimes to replace a higher interest-cost debt like credit card debt. Credit card debt rates of interest are usually upward of 36 percent per annum.
In India, banks offer pre-approved personal loans at interest rates that range from 16 percent to 20 percent per annum. This loan market is dominated by aggressive marketing and customer outreach. Customers with good public credit profiles are often targeted with such loan offers.
Today, global liquidity in Europe, Japan, and the US is high. But the trend is rapidly changing with Central Banks rapidly raising interest rates. High liquidity, low-interest rates is a huge business opportunities for lenders. In such times, an unsecured loan business with an interest rate of 20 percent is a great source of profit for lenders.
According to Forbes, some leading personal loan companies include Sofi, Lightstream, Lending Point, Upgrade, Universal Credit, Discover, Upstart, and Avant. Some years back, I had the opportunity to interview the Founder of a European startup. I wanted to understand the unsecured market as it existed in Europe.
The startup
Creamfinance is a startup based out of Latvia. They started unsecured loan lending in 2012. It was a time when Europe was at the depths of an ongoing financial crisis. Unemployment levels were high. Overall demand had plummeted. But it was also when demand for unsecured loans across the region would have shot up.
Creamfinance uses publicly available credit data to analyze and identify target customers in the East European and Scandinavian markets. This publicly available information on individuals is machine analyzed to determine prospects. One-click, no, questions-asked loans are offered to such customers.
Creamfinance focuses on small ticket-size loans. Their average loan size is just Euro 200. The credit period for such loans is short. It averages just a month. The market segment of ultra-small short-duration loans is particularly interesting.
It makes it possible for a lender to roll over a relatively small amount repeatedly. Credit is offered to many customers, repeatedly compounding its effect. It helps enhance market reach. With more numbers benefiting from these loans, that aids in brand building and helps build brand recall.
Cost of funds, marketing, other overheads, business processes, and sales costs are key determinants that dictate a company’s base costs. Below these costs, lending becomes non-profitable.
Large companies like the big banks can access funds at a much lower rate than smaller companies like Creamfinance. Much of this, though, gets offset by the high overheads of big lenders. They prefer to avoid chasing ultra-small value loans of the type being offered by Creamfinance.
Roadmap to profitability
Matiss Ansviesulis, the startup’s Founder, is an ex-JP Morgan executive and understands the market well. They identified this ultra-small, extremely short-duration niche market. As a startup, they understood that their cost of funds would be relatively high. But they also know this falls as the business expands.
By keeping overheads down, a startup can rapidly generate surpluses provided non-performance loans only go up to a point. Matiss placed Creamfinance, bad loans between 6 to 7 percent, much lower than the EU average of 10 percent. Surpluses generated by rapid fund turnover make it possible to plow these back and expand business organically. It explains the observed fast pace of expansion of this company.
Their edge is not fintech and smart data analytical capability. After all, customer credit profile data is publicly available to all lenders. Fintech analytical tools are also standard. Also, investments into tech, which large companies can make, can never be matched by a startup.
The edge of a startup lies in their identifying the niche marketplace. It has to be supported by sound business strategy and management skills. Publicly available growth information on Creamfinance indicates that team Creamfinance can muster all these skills.
Creamfinance is a good case study for many budding entrepreneurs seeking to find a niche for themselves in the global marketplace. Often many startup Founders look around for that one killer idea that will take them on the fast path to becoming a unicorn. In a small percentage of startups, this logic does hold.
Business success
After interviewing dozens of startups and analyzing many more businesses, I have learned that startup success and performance are not just a factor of innovation alone. It has to be supported by sound business strategy and management skills. Matiss and his team have taken a pragmatic approach to business. It can lead them to become one of the first unicorns of Latvia.
Like in any business, an unsecured loan also comes with business risk. At the same time, the demand for unsecured personal loans will not decrease at any time. Micro-credit lenders will increasingly come under pressure from regulators to keep the interest rate down. Poland and Latvia in Europe and India regulators are adopting different approaches to ensure lenders do not charge usury interest rates.
In India, competition in the micro-credit business was introduced by issuing licenses to small banks. Microcredit companies are reading the writing on the wall and are innovating. Creamfinance will also need to do this in the future. Until such time, they are onto a gravy train.