Why Nigerian Fintechs are Gradually Morphing Into Lenders

Some months back, one of my neighbors who works with AXA Mansard bought a Geely Coolray. Nothing special about that, a Geely Coolray is a Range-Rover Evoque with a sharp face and a horizontal shield logo instead of the iconic and symbolic Landrover logo.

Beyond this however is a testament to the growth of the vehicle lending space in Africa, a growth that firms like AutoChek have made possible, partly by being one of the early movers in the space, and partly by consolidating the market via an aggressive acquiring spree. Nothing aggressive about acquiring 4 companies (at least on a global scale), but in a market where startups largely prefer to spread organically as against inorganically via acquisitions, that says a lot.

Today, if you earn N600,000 (US$1000) a month in Nigeria and you’re serious, you can save N225,000 (US$375) of that a month, and after 8 months have the 30% deposit (N1.8m (US$3,000)) required to make the down payment for a Foreign used 2015 Toyota Camry which retails for about N6million (US$10,000). The growth of the vehicle lending space is phenomenal.

People think Moove is in the mobility space, like this author that called them an “African Mobility company with a fintech play”, or this author that calls them a “ Nigerian Mobility Startup”. Moove is actually a B2B fintech lender with a specific niche – revenue-based vehicle financing (i.e the guy I’m giving car financing to is using that car to make money), calling them a mobility startup is like calling Starbucks a coffee shop (they’re more likely a bank considering they have more than US$1.4bn in interest-free “customer deposits” via their loyalty cards, etc ), or calling Apple a consumer goods company, considering it makes money selling products to consumers. Understanding that this is majorly just marketing speak and Apple is actually a luxury brand because only a luxury brand can sell a basic product like a smartphone and make a 100% mark up on it as profit, just by slapping a brand name on it.

When a young lady in her 20s earning N250,000 (US$416) a month is willing to save or pay N300,000 (US$500) in 4 monthly installments just to buy a second-hand 128GB iPhone 12 Pro (that she probably doesn’t need), you’ll realize that it’s more than just the functionality of the phone she’s paying for, she’s also paying for the signaling that comes from using an iPhone. It’s like luxury watches – a US$35,000 Hublot Big Bang time-piece will not tell you what time Jesus is coming, but in the right room and amongst the right people, it’ll signal that you’re a person of value and significance, considering you’re carrying two foreign used Toyota Venza’s on your wrist (and with the way the exchange rate is going, possibly three). But I digress.

The use case and demand for lending has grown in leaps over the years, and I believe strongly that Nigerian fintechs are gradually morphing to serve that market.

UNDERSTANDING THE NIGERIAN PAYMENTS LANDSCAPE

For those who do not know, payments is generally a low-margin business. Payment companies charge a Merchant Service Charge fee (that is usually regulated by a regulatory agency) for transactions on their platforms.

In Nigeria, this charge is capped at a maximum of 1.5% for local transactions, and around 3.5% for international transactions. What this means is that for every transaction processed via a payments gateway, the gateway keeps 1.5% as gross revenues. This also indicates that payments is a scale business, scale meaning that transaction volume somewhat culminates into higher revenues, similar to how eCommerce companies operate where scale (In this case GMV) is (or should be) equal to higher revenues.

However, the payments acceptance process in Nigeria both for CNP (Card not present)/online acquiring and Card present/offline acquiring) transactions in Nigeria involves multiple stakeholders who make up the value chain and also take a cut of that 1.5% MSC. A typical online acquiring transaction involves 6-7 main stakeholders;

Issuing Bank: The Bank that issued you a card i.e Zenith Bank, GTBank, etc.

PSSP: The owner of the gateway you’re inserting your card details into i.e Remita, Paystack, etc.

Card Processor: Player responsible for processing card transactions e.g Interswitch, UPSL, PayU, Cybersource, etc.

Card network: Network responsible for routing transactions i.e VISA, MasterCard, etc.

Transaction Switch: A tool that allows for transaction routing between the various stakeholders during a transaction.

PTSP: The company issuing the merchant a payments terminal (POS terminal) – only applicable for in-person transactions i.e Global Accelerex, Itex, etc.

Acquiring Bank: The bank the merchant deals with i.e Zenith Bank, GTBank, etc.

NIBSS: Nigerian Central Switch for settlement.

Each of these stakeholders keep a cut from the 1.5% merchant service charge for the transaction, and at the end of the day, the PSSP ends up with a lesser percentage of that to record in their books as net revenue.

For context purposes, Stripe, the US-based Fintech company charges 2.9% plus 30 cents per transaction to accept card payments. This is significantly higher than what its Nigerian counterparts are permitted to charge. Stripe reportedly processed about US$640billion in transaction volumes in 2021 (slightly less than what the entire Nigerian ecosystem pushed digitally including NIP in 2021) with gross revenue at US$12 billion and net revenues of almost US$2.5billion. Net revenues of US$2.5billion indicates Stripe keeps approximately 0.4% of what it processes or 13% of its total Merchant service charge.

However, Stripe is not a conventional fintech that makes money from only transaction processing, as it offers a plethora of services to merchants on its platforms including virtual card issuance, capital solutions, startup incorporation, etc.

p.s: this US$640billion in transaction volume is across all 50 countries where Stripe operates and may also include Paystack volumes.

THE SWITCHING STRATEGY

Nigerian Fintech companies in a bid to bolster profitability are therefore looking for ways to feature more prominently in the payments value chain and bolster ARPU from existing users.

Acquiring a switching license has become a good way to execute this. I mentioned in an earlier post that Fintech 1.0 players like Interswitch and UPSL who own the majority of the switching market in Nigeria, partly because of the first mover advantage they had, and partly because prior to now, card switching has really been the only (or most profitable) kind of switching to engage in Nigeria considering that more than 30% of online transactions in Nigeria occur via cards (yes! Nigeria is not a mobile money market).

I’ve always believed that as long as card switching exists, the two aforementioned firms would continue to dominate that space –  considering the cost of maintaining such infrastructure yourself or trying to convince banks and other financial stakeholders to yank off a UPSL or an Interswitch may be difficult, however, recent developments in the fintech space have shown that while yanking off a card switch may still be undesirable, companies with significant transaction volumes are choosing to switch and process their own transactions – Companies are going ahead to acquire switching licenses.

Over the last 6 months, Remita acquired a switching and processing license from the CBN, but Remita is only one company – TeamApt also acquired a switching license, so did Appzone, Paystack, and HabariPay (GTCo’s fintech arm). I can bet blood and water right now that if Flutterwave doesn’t already have an Approval in Principle Switching license from the Central Bank of Nigeria they haven’t publicly announced yet, they at least have some kind of document with the CBN payment system division applying for one.

According to the Central Bank of Nigeria’s Framework for licensing switching and processing companies, switching and processing companies in Nigeria are allowed to offer switching services, card processing, transaction clearing, settlement agents services, and non-bank acquiring services. The TL;DR of this is that payment companies with this licensing type can reduce reliance on third-party transaction switches for switching and processing and choose to process their own transactions, thereby extracting more value from the payments value chain.

However, this doesn’t in any way mean that the Fintech 1.0 players already providing these services will become redundant – far from it, but it does mean that a significant portion of transaction volumes passed on to these switching companies for processing will likely be self-processed by these companies themselves. I expect more payment companies processing huge transaction volumes to follow this route.

Beyond transaction switching, however, a switching license allows its holder to act as a PSSP, PTSP (Payment terminal Issuer), and a Super Agent. This means excluding normal PSSP operations, a company with a switching license can issue payment terminals to its merchants and run a super agency network.

What this means is that for a typical offline card transaction, Remita or Paystack who would ordinarily play one role – PSSP, can now directly offer 3 out of the 7 services (PSSP, PTSP, and switching) in the value chain thereby capturing more value for itself in the process. A company like HabariPay which is a subsidiary under GTCo can also find itself in transactions where it can offer 5 out of the 7 services required for a physical transaction to go through by being the PSSP, PTSP, and switch, but also the issuing and acquiring bank via GTBank.

This ultimately means that payment companies are now positioning themselves to increase their net revenue per transaction processed from payments and also bolster it via other value-added services, one of which is lending.

The Lending play

Lending is a big business. Banking is lending. Between the top 5 Nigerian banks by market capitalization (FUGAZ), about N1.386trn (US$2.3bn) was made in interest income (revenue from lending) in 2021 alone, which represented an average of 40.4% of portfolio income.

The appetite for lending in Nigeria is also huge, both from a consumer lending perspective, and an SME lending perspective. Banks are ordinarily supposed to be well positioned to feed that market, but they aren’t. While banks are very comfortable lending to billionaires, large corporate entities, and individuals with steady sources of income (salary earners), they fear lending to normal consumers and SMEs. High NPL ratios can be detrimental to the existence of a commercial bank, and the latter category of users are usually harbingers of such, especially when such loans are uncollateralized.

When a billionaire takes a loan from a bank, his 5 bedroom house in Lekki Phase 1 and his 2021 Bentley Bentayga have been placed as collateral, if he defaults, the bank has a nice piece of real estate to sell (or wait for it to appreciate in value then sell), and a nice car for someone to bid for and buy. A salary earner will always receive a salary, and a large corporate entity has a lot to put on the table as collateral.

But if Mike takes a non-collateralized loan from the bank for personal expenses and he can’t pay it back – it’s on God. No joke, and since banks rarely shame people like loan sharks, Mike MAY end up going scott-free, albeit his name may get blacklisted and placed on some database that may severely hamper his chances of receiving credit in the future (if that database is shared with the relevant parties off course).

SMEs also struggle to access business loans for their businesses, because while they may run profitable businesses, their poor bookkeeping may simply hinder them at the banks. Some consumers also feel emboldened to not pay back loans (except when the consequences include you being accused of all manner of things by loan sharks).

The US economy is built on credit. A poor credit score in the US is somewhat tantamount to economic suicide. Fred’s iPhone 13 Pro was acquired on credit (he’s paying monthly for it), his Mercedes E series is also on credit – he has a car note on it, and the new house he announced was also on credit – he has a 25 years mortgage to pay on that property, including taxes. The fact that there is a shared credit bureau database in the US means the consequence of a loan/credit card default is severe. In Nigeria not so much.

Fintech Plays

Nigerian fintech companies recognizing the potential and market opportunity in the lending space are building multiple business models around it. Almost every payments company today in Nigeria has a lending play – Flutterwave announced Flutterwave Capital at its Flutterwave 3.0 event earlier this year, and also hired two key executives this year one of which is Oneal Bhambani a former VP at American Express with years of experience offering business enablement and credit solutions to SMEs. Interswitch has Quickteller for loans, TeamApt has a lending play it piloted with its agency business, and Remita empowers the lending economy via a proprietary solution that doesn’t just give lenders access to salary records of over 3 million users on its platform to enable them make better lending decisions, but also helps increase loan repayment by initiating loan repayment at source (i.e debiting the borrower directly from his employers end before the money gets to his account).

Every fintech offering business banking and SME enablement solutions today is largely poised to monetize via lending to the SMEs on their platforms – Brass Banking, Kippa, Prospa, Bumpa, etc.

All digital banks largely employ the same strategy – free float from users transacting on their platforms to power lending to the same users and make a decent markup – Kuda Bank, Fairmoney, Sparkle, Carbon, and Kredi Bank. In fact, I personally believe a digital bank that cannot offer credit to its users will likely underperform, especially when free transactions on its platform are a key part of its customer acquisition strategy.

Even M-Pesa allows its users’ access loans from its banking partners (likely based on their M-Pesa transaction histories) and possibly keeps a cut on revenues. Non-fintech businesses like TradeDepot, and OmniBiz offer BNPL (Buy Now Pay Later) services to their merchants to bolster transactions on their platforms, while open API banking players like Mono and Okra recognize that the biggest use case for transactional data and statement APIs is still to power credit-scoring for lenders.

I personally do not expect companies to slow down in their extension of credit to their users as a way to bolster and increase ARPU.

CONCLUSION

The growing use cases for lending in Nigeria and the relative gap in the market continues to create opportunities for fintechs to serve this market, and as more fintechs continue to desire profitability and revenue growth, directly offering credit and/or empowering the credit economy will continue to look like an attractive avenue to venture into.

Inspired By The Holy Spirit