Over the last few years governments, NGOs and to a lower extent the private sector, had all invested huge efforts and capital to provide the unbanked population in emerging markets with access to the formal financial system. The common belief is that financial inclusion will enable governments to remit funds to their citizens in a more safe manner, thereby reducing corruption and fraud. In addition to financial inclusion, the migration to digital payments will also enable individuals and businesses to transact in a manner that is both cheaper and safer, thereby promoting entrepreneurship and growth.
The growth in digital payments for the unbanked over the 10 years has been phenomenal through different mechanisms such as mobile money in Sub-Saharan Africa or government-initiated remittances services in India. However, a large portion of the population had moved from being unbanked altogether to being underbanked, i.e. they can now transact digitally but the majority of them are unable to obtain easily access to credit and additional banking products that are considered critical from true financial inclusion.
The Challenge in Lending to the Underbanked
Providing the underbanked with access to credit is not an easy challenge. In the traditional lending process, the applicant is required to physically visit a branch or an agent to fill out a credit application form that usually takes several days to assess, and whereby the assessment is performed manually. Traditional lenders rely on the applicant's credit history, collateral such as property or deposits or a steady, documented income such as a salary. Most of the underbanked lack these three key assets: they have never taken credit before and therefore they have no credit history, in many cases they have no assets that can be used as collateral and most of them don't work in the formal economy, thereby lacking a steady job or a formal salary slip.
Making things even more challenging is that the underbanked typically need relatively small loan because that is what they are able to repay, but the traditional lending process in formal financial institutions such as MFIs or banks are labor intensive and carry a fixed operational cost that makes the granting of small loans unprofitable for the financial institution.
Many developed financial institutions have transformed many of their credit processes from traditional lending to digital lending. Obtaining a loan digitally in developed economies requires the customer to fill out a credit application form digitally with the decision made immediately. Validation and disbursement typically occur within 24 hours. While digital lending streamlines the lending process by making it more efficient and cheaper, it focuses on customers that already have some recorded credit history, either with the financial institution or with a centralized credit bureau. Therefore, traditional digital lending doesn't effectively grant the underbanked with access to credit.
Collaborative Lending - The Enabler of Lending to the Underbanked
We believe the next evolution in credit is Collaborative Lending. Under the Collaborative Lending model, an existing financial institution partners with a non-financial partner, whereby the non-financial partner provides detailed data on each existing customer that has specific credit needs. The financial institution funds the credit and uses its underwriting know-how as well as its regulatory framework and lending license.
This collaboration enables a very efficient and cheap process, because the non-financial partner supplies the credit lead, thereby yielding a very low cost of customer acquisition for the financial institution. The financial institution receives validated customer data from the non-financial partner, making the operational cost very low. The financial institution disburses the funds immediately and directly through the non-financial partner, thereby reducing fraud risk.
Collaborative Lending - An Excellent Solution for Many Use Cases
We believe Collaborative Lending could be relevant for all unsecured loans:
- When an unbanked individual uses his or her mobile money application and has no balance to pay.
- When an individual purchases a home appliance such as a refrigerator, and the merchant offers that purchaser a bank loan to finance the purchase.
- When a small business wants to buy from his or her current supplier.
Collaborative lending benefits all parties:
- Customers save time and effort, getting credit when and where it is needed and at a lower price.
- The non-financial partners will reduce customer churn and increase their customer value through additional income related to credit.
- Financial institutions will enjoy from a new target market of potential borrowers that can be very efficient and deliver a higher ROE than these financial institutions' existing digital or traditional lending.
Financial institutions, primarly banks could partner with MNOs, utilities companies or large retailers to serve personal customers or industry aggregators that sell or buy products from a large pool of microentrpeneurs
A common collaboration use case is for a bank to join forces with an MNO and access its customer data in order to grant credit.
MNOs usually have a large customer base of both the unbanked and the underbanked segments of the population with a unique data history that includes:
Mobile money transactions.
The Challenges of Collaborative Lending
Collaborative Lending provides great value for all the parties involved but also poses some interesting challenges:
- Ethical - can data collected for one purpose be used for another business purpose?
- Business – is there a way to ensure that all the parties involved find Collaborative Lending beneficial from a business perspective?
- Technological - is there a way in which Collaborative Lending delivers a secure, simple and fast lending process?
Analytical - is there a way in which the vast amount of new data available through Collaborative Lending can be effectively analyzed?
In the next post we will share with you some of our insights in these challenge.