A study by the SA Reserve Bank has found that revenue-based financing has emerged as a significant alternative to traditional lending for small and medium-sized enterprises (SMEs), with the research giving further insights into SA’s informal market.
The working paper by the Bank, penned by Dominic Russel, Claire Shi and Rowan Clarke, looked into data from more than 100-million transactions from a South African fintech platform, which it did not name.
The platform primarily offers card-payment processing machines and online interfaces to small businesses, currently processing over $2bn in transactions per year for 250,000 active users, according to the Bank.
In addition to processing transactions, the platform offered a revenue-based financing “capital advance” product that borrowers repay with their daily processed payments. The Bank’s study showed that advance takers were generally small, consumer-facing businesses and entrepreneurs operating hair salons and food trucks businesses among other sectors.
The platform has over the past eight years issued more than 65,000 advances and re-advances to small businesses.
First advance takers had an average of R120,000 in sales over the prior three months, according to the data analysed by the Bank.
The effect of this model is that when a business takes the advance, the platform deducts a constant share of its daily transactions until the principal plus a fixed fee is repaid. In essence, an increase in processed revenue results in faster repayment, while a drop leads to slower or no repayment.
“This contract moves some risk from the business to the financier, as there are no additional interest charges if revenue falls and there is no required repayment if the business fails,” the study found.
Because of how the model is designed, it opens up the lenders to certain risks, including revenue hiding by businesses taking up the advances to avoid repayment.
The Bank’s study shows that advance takers are generally small, consumer-facing businesses and entrepreneurs operating hair salons and food trucks businesses, among other sectors.
The working paper looked into whether advance takers reduced the cost of financing by “hiding” revenue using alternative processors or cash and, if so, when would a fintech company be better or worse at mitigating this friction.
“Our results in this section suggest fintech platforms can mitigate ex-post financial frictions with non-lending features that are not substitutable. These features, like payment processing, increase the cost to small businesses of hiding revenue from repayment,” the study said.
“The ability to mitigate financial frictions may allow fintechs to expand credit access or enable revenue-linked repayment flexibility that encourages entrepreneurial risk taking.
“We highlight the importance of fintech innovations in promoting financial inclusion and supporting the growth of small businesses in SA as well as in sectors in developed and developing countries elsewhere.”
Business Day reported last month that the Bank was pushing for an overhaul of the country’s payments regime with non-banks set to enter the clearing and settlement system in a move that will see the hegemony of the traditional banks further challenged by fintechs.
For this to happen, the regulations governing SA’s payments landscape would need to be changed, a task that Tim Masela, head of the SA Reserve Bank national payment system department, said the Bank was engaged in.
This is as the Bank, which is the custodian of the national payments system, said managing cash in the system costs the economy about R30bn annually — nearly what the state pays in social relief of distress grants.
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