Keeping pace with alternative finance

The report was launched on October 22, 2019 at the SCxSC Fintech Conference 2019, hosted by the Securities Commission of Malaysia, who was also our technical partner on this research. Funding was provided by the World Bank Global Knowledge and Research Hub in Malaysia, funded by the Malaysian Government.

With a decade left to achieve the SDGs, policymakers are seeking ways to spur inclusive growth.  Job creation and the role that SMEs play is critical to making this happen. In many countries these firms face significant problems when trying to have access to finance -equity or debt-. In recent years “alternative finance” has become a new and important solution that offers great potential for expanding access to capital. But is it really something that can be scalable?  What are the main benefits and risks? Are countries ready to adopt it in their regulatory frameworks?  

We just launched a new report in October, Regulating Alternative Finance: Results from a Global Regulators Survey, which was produced jointly with the Cambridge Centre for Alternative Finance (CCAF). This research is based on a survey conducted between April and June 2019 to which more than 110 jurisdictions responded globally – mostly securities regulators. Responses revealed a lot about the change regulators expect in the short term. Fifty percent of respondents are planning to review their regulatory frameworks for equity crowdfunding within the next two years while about three in ten are considering changes to their regulatory frameworks for ICOs and P2P lending.  

Looking at data broken down by income levels, resources available for regulation and region, the survey reveals more change in lower income countries with more than 80% of countries and almost 64% of countries in LAC and Africa expected to change the regulatory framework for crowdfunding by early 2021 respectively. 

Tracking this change and engaging with its implications calls for an understanding of triggers driving the trend toward regulation of alternative finance.  Three perspectives come to mind:  

• First, as alternative finance grows at the national and international levels, demand for regulatory clarity gains importance. Data from the CCAF shows that growth in alternative finance has been fast-paced across a wide range of economies and across regions. In the U.S., CCAF data indicate that from 2013 to 2017 the alternative finance industry nearly doubled in size each year (88% average annual growth). Data from European markets shows rapid, although slowing, expansion as the industry grows – with 36% year-on-year growth for 2017 (the latest available data). Alternative finance has also gained a foothold in many emerging markets where it is also registering rapid growth; annual regional growth rates include 118% in Africa (2016), 80% in Asia (2017) and 97% in Latin America (2017). China is the undisputed leader in alternative finance with an estimated $358 billion facilitated through platforms in 2017. 
   
• Second, good practices are beginning to emerge – which makes regulation easier for late adopters. Our survey results tell us that regulatory benchmarking is a crucial input into regulatory change in alternative finance – cited by more than 90% of survey respondents when asked how they develop regulations. Regulators learn from each other – including their successes and failures. Early movers didn’t have a lot of precedent to benchmark against; now, however, it is becoming easier to find examples of good practice and adapt them to local needs.  
   
• Third, new objectives at play offer an opportunity to expand benefits and responsible access. Many regulators have mandates that include financial sector development issues such as financial inclusion and competition, providing further impetus to take steps to strengthen the environment for inclusive innovations such as marketplace finance. We know from our recent survey that regulators overwhelmingly see the potential for positive impacts on the underbanked and unbanked from new alternative finance businesses such as peer-to-peer lending and equity crowdfunding. The survey data indicate that 79% of regulators expect a positive impact on SME financing and 65% expect a positive impact on consumer finance, with 56% responding positively to a more general question on the impact on “financial inclusion”.  It is also important to note that competition in financial services is seen as a major beneficiary of alternative finance / fintech – by more than two-thirds of the regulators surveyed. Often competition results in lower costs and reaching to new, previously unserved market segments, which promotes financial inclusion. (See Figure 1.3 below.) 

Our partner in this research, the CCAF, has extensive industry data on peer-to-peer lending, equity crowdfunding and other significant types of alternative finance such as invoice trading platforms which shows the impact these tools are already having on underserved market segments around the world.  

• Equity crowdfunding seems to have a positive impact on financial inclusion in Malaysia as 70% of beneficiaries are businesses owned by women or young entrepreneurs (under 35), based on data in Cambridge’s study of the Asia Pacific.  
• 19% of fintech lending customers in ASEAN countries are unbanked, 47% are underbanked.   
• In LAC, 27% are unbanked and another 24 % are underbanked. In places like Mexico, 37% of borrowers are unbanked and 21% underbanked; in Chile 56% are unbanked.   
• In Africa and the Middle East, as of the last estimate (2016 data), Cambridge data suggest that about one in every seven dollars raised through alternative finance were via online microfinance platforms targeting poor and underserved people.      
• In the UK, Alternative Finance now makes up 29% of small business loans (not SMEs, ‘small’ by the UK Finance definition, so under £2m turnover) and 13% of all seed and early-stage equity investment.   
• 28% of US alternative finance fundraisers are under-banked (none are un-banked)  

Efficiencies in service delivery gained through data-driven platform finance models, coupled with the increasing comfort level for consumers using online financial products and services, can create a promising environment for new entrants.  Opportunities for peer to peer lenders and equity crowdfunding, as well as for incumbents looking for new delivery channels and partnership are on the horizon to bring us closer to inclusive growth. Proportional regulations are also part of the environment that is required for alternative finance to thrive, and many jurisdictions are poised to act in the coming years. This is good news for the millions of small businesses globally who could benefit from improved access to finance and contribute to accelerated progress toward achieving the SDGs.