Paylater, the Nigerian online lending ecosystem, continues to grow. It noted few days ago that its app has been downloaded more than 500,000 times. I wrote a comprehensive piece about its operations and opportunities few weeks ago. Indeed, Nigerians want money and they are following the easier path since banks will keep asking for collateral which the very people that need the loans do not have. The banks are right to ask for same because they are keeping other people’s money. That problem will be solved when Nigeria has a credit system to ascertain credit worthiness of borrowers.
Paylater brilliance is that it can offer very fast loans to people without collateral. Though the loans have above-banking interest rates, at least the people have the money.
Paylater is pioneering a new area in fintech along with other lending startups in Nigeria. Though their annual interest rates can vary from “31% to 213%”, for most people, it is better than nothing. Simply, they are meeting the needs of customers, left behind by banks. For the very fact that they are CBN regulated, it means that they have to disclose every element of their loan terms in ways that customers will understand.
For Paylater, the firm is totally online, away from the bulk of the people that need its loans. That is the main weakness but also the strength since the Internet gives its unbounded distribution channel to scale, even while excluding the millions of Nigerians who are not yet online. Most of the excluded people are the people that desperately need the product. But Paylater has to start from somewhere and succeed first. It cannot serve everyone. The Internet helps it to operate lean with positioning to serve its desired customer segment efficiently. I see brilliance in this company and its mission.
But as this firm expands, this company will have to deal with one major irony: it may need collateral itself to get funding from banks, before it can lend. Yes, it can make its own loans without collateral but getting that money to lend will be hard. Of course, it can overcome that challenge by selling equities to investors. That is probably the best capital for the business. I am really surprised that it has not done that already, based on the apparent traction with its app. Sure, app download is not the key indicator of financial health for a fintech.
The fintech lending business in Nigeria and Africa will be won by four things:
- Ability to have cheap capital to lend: You need cheap capital for this business. Equity will be an optimal option when families and friends cannot help. But where such options are not possible, companies like Paylater will have to take debts which is usually at high interest rate
- Ability to lend that capital as fast as possible. You do not want to keep expensive capital in your bank account. It needs to start working immediately. And that means lending it out to customers.
- Higher lending rate: You need to make sure that the interest rate paid by the borrower is higher than the cost of capital, plus expenses. Yes, you need to lend at a higher interest rate to have a chance. This is catalytic to the business survival: making it clear that your interest rate is what it is (yes, very high) without freaking people to forgo the loan.
- Near single digital default: This is the heart of any lending business. You need to make sure that you are lending to the right people. That is one way you can have a good business to service your loan from a bank or even grow as a business. By keeping default low, you can engineer profitability. This is the most important aspect of the business in a country with minimal credit score.
Warren Buffet Strategy and Marginal Cost
To have a sustainable business in this sector, lending fintech needs to follow the business philosophy of Warren Buffet: have access to cheap capital to finance growth. Yes, Warren Buffet’s business controls Geico, an insurance company, which provides cheap funding through insurance premiums paid by customers. With that cheap capital, the company can put capital in businesses that will take very long to deliver great results.
I do think that startups like Paylater have to consider that model: it needs a way to attract cheap capital which will be needed to lend to customers. Even if it can borrow from a bank, that does not change this insight because if it has cheap capital, its margin will improve. Here are ways it can do this:
- Acquire Piggybank: Paylater needs to acquire Piggybank, a Nigerian online saving platform. Upon acquisition, it must keep it as an independent operating company, under Paylater’s parent company OneFi. Piggybank is in the business of getting customers to save their money with it, offering largely above-banking saving interest rates, which is fair. And it has the incentives to entice these customers to keep the money for longer. That is the key, you want customers to come and save for longer period since Piggybank has to put that capital to work. It cannot just keep the money in the bank. By acquiring Piggybank, Paylater will have access to those funds to lend to the other side of the customers. Here the Piggybank is like the Geico to Warren Buffett and that means Paylater has access to cheap funds.
- Partnership: There is also a possible option for partnership where sharing data could help companies like Paylater to work with Piggybank. Yet, that partnership can be on user data and should not necessarily include Piggybank funds since Piggybank cannot unilaterally risk client funds to support an external company like Paylater without collateral. The Central Bank of Nigeria will likely not approve such plays. This means that partnership will not unlock the saved funds in Piggybank for Paylater. However, Paylater can borrow under regulatory terms such funds to invest.
- Build a Savings Business: Where it cannot acquire Piggybank, it needs to find a way to build a savings business. But this savings business must be operated independently despite being a unit in its OneFI holding company. This savings business will help to generate the cheap capital for lending.
Besides, for Paylater to do well, its marginal cost must be low. The digitization of its operation has taken care of the operations. It costs largely nothing to add a new user. However, the capacity to lend to a new user becomes where the business will win or struggle. What is that marginal cost? It cannot answer that question until it has a clear roadmap on how it funds its loans. I do not think that debts will be a sustainable path. But without equity, that may be the only option. I have also noted in their website a reference to DFIs (development finance institutions) like African Development Bank. It remains to be seen if DFIs in their typical natures will support high interest lending business to largely non-wealthy citizens.
Building an online business in Nigeria will remain challenging for a long time since the rich citizens are not yet online. The implication is that size will play a role, and what works in places like U.S. and Europe may not work here. For online lending startups, the arbitrage between cost of capital and lending rates (with default rates) must be well structured, otherwise liquidity issues could happen. The key to this business will be the players coming together so that they can have scale to compete in the marketplace. Industry-leaders like Paylater (lending) and Piggybank (saving) could set the stage and come together. If that happens, even the banks will notice that fintech is on the march. I am very confident that size will play a role and M&A(mergers and acquisitions) in the Nigerian fintech sector will unlock more capabilities to accelerate innovation in the land. Paylater should acquire Piggybank.