By Paul Randall, Executive Director from credit risk management experts Creditinfo
According to the World Bank’s Global Findex Database 2017[i], 69 percent of adults worldwide have an account, either with a financial institution (i.e. bank account) or a mobile money provider. Financial services are the bedrock of a nation’s economy, funding and providing access to other critical services including health, education, entertainment and business. Yet the stark reality is that 69 percent is too small a number. A whopping 1.7 billion adults across the globe remain ‘unbanked,’ with no bank accounts and no access to formal finance.
Most, if not all, of these unbanked individuals live in the developing world, in regions such as Africa, India and China. What’s more, an additional 200 million micro-, small- and mid-sized businesses in growth markets lack access to savings and credit, according to a recent McKinsey report[ii]. A lack of banking infrastructure in these developing markets has led to significantly lower numbers of formal finance. This lack of formal finance creates a poverty trap that is hard to climb out of. Poor people around the world are relying on cash to pay their utility bills; budding entrepreneurs are overlooked for loans because of a lack of credit history.
But the outlook needn’t be so bleak. The good news is the unbanked population is slowly diminishing. But how can we close the financial inclusion gap even more swiftly, on the road to universal financial access in the not too distant future? The answer lies in the innovation that both incumbent and emergent fintech companies are bringing to the credit risk management table.
By changing current approaches to credit lending, and providing those with lending power with a new mentality, and the infrastructure required to make better decisions, we can tap into an unbanked and underbanked population to the benefit of economies globally. Here, we’ll take a look at what this road to financial inclusion looks like in reality, particularly for developing regions such as Africa – and it’s more practical, achievable and realistic than you might initially think.
Potholes in the road to financial inclusion
Consulting firm Accenture has estimated that bringing unbanked adults, as well as businesses, into the formal banking sector could generate about $380 billion in new revenue for the financial services sector. With $380 billion to gain, why wouldn’t players in the industry want to unlock that potential?
A report by the World Bank[iii]outlined the importance of infrastructure in support of economic growth. This is specifically pertinent for developing markets, where access to infrastructure, or the ability to build a banking infrastructure from scratch, is often just out of reach.
The historical infrastructures designed to manage corporate loans and consumer savings are ill-equipped for the challenges generated by both the substantial increases in volume of credit and the specific requirements of an unsecured lender. This lack of infrastructure is especially poor for the initial risk assessment, where much of the process is manual.
The development of a robust banking infrastructure, underpinned by government and private sector investors and the participation of local and foreign businesses, is imperative in unlocking the huge population of unbanked and underbanked individuals in developing regions.
In a recent blog by The Brookings Institution[iv], a US non-profit public policy organisation, Africa was proclaimed as the continent of the future. For some years now, the World Bank has driven an initiative to promote the installation of credit bureaus across Africa and other developing regions, with a view to facilitating lending to consumers and small businesses.
If you build it, they will lend
The International Finance Corporation’s(IFC) Africa Credit Bureau Program supports economic growth on the continent by providing the advisory services, infrastructure, credit risk management technologies and support to central banks and other private sector stakeholders in order to build a banking backbone that supports increased access to formal lending. Part of this program involves the development and implementation of credit information sharing, supplemented by automated application processing systems so that lenders can make more informed decisions more quickly, and at scale.
These credit bureaus play a crucial role in creating the infrastructure that has been so severely lacking, by allowing banks to make lending decisions based on quantitative models of risk. This means banks and other lenders can provide access to financial services at a lower cost, to more people, while also reducing risk. However, the conundrum in Africa lies in providing access to financial services to individuals who have very little or next to no credit history, thereby making it difficult for those credit bureaus to provide an accurate picture of solvency to lenders.
You can teach an old bank new tricks
“When there’s little information, then there’s little financing,” said Luz Maria Salamina of the IFC.
Traditional lending and underwriting methods typically screen out the huge pool of ‘thin file’ customers that reside in developing markets like Africa. These are customers without a credit history, or one that’s too small for traditional risk analysis. Thin file companies are typically very poor – they’ve been ignored by the formal sector, and as such tend to pay for services with the little cash they have. So, without information on the billions of these individuals currently without access to finance, the financing stops.
Enter fintech disruptors, who are facilitating change in the credit lending industry by helping banks to tap into and use new sources of data that can unlock both the large pool of thin file customers and, by extension, the wider unbanked population. Some of the largest investors into fintech companies are banks, with some mainstream lenders now acquiring, adopting and developing the new technologies that these fintechs have created. What’s more, established, best-in-breed credit bureaus have adopted these fintech techniques, providing banks with a single source of data, whether that’s through a traditional credit file, or a digital file of aggregated data.
These fintech companies have made an excellent job of mining new data sources from social media, mobile transactions and trade data. Amazon is an example of this new way of thinking – the tech heavyweight used its vast data source to lend $1bn to SMEs over the last 12 months. Companies like Amazon have been able to teach banks new tricks when it comes to making better decisions more quickly, particularly when it comes to thin file customers.
Better the debtor you know
Normally, credit histories are a record of a borrower’s ability to pay back debts. Sources of data include banks (does Bob pay his bills on time?), credit card companies (how many credit cards does Bob have?) and collection agencies (has Bob previously defaulted on any debt, such as loans?)The data is combined, an algorithm is applied, and the subsequent report details how likely it is for that particular borrower to pay back or default on debt in the future. As banks and fintech companies join forces to harness innovation, they are unlocking new data sources, which include the new concept of psychometric testing to fill in the gaps on thin file customers. While it’s true that not everyone can currently access credit, everyone has a personality.
There are now new, innovative solutions for credit lenders to measure the risk of potential customers who may have been overlooked for formal finance in the past, by assessing their core personality. Just like credit bureau data, where millions of raw variables are split into segments such as default, early stage and revolving arrears, or credit card performance, so personality data is split into segments in a similar way.
By uniting psychological models with traditional risk analytics, lenders can reduce risk with existing customers and start new relationships with prospective customers, thereby increasing affordable access to financial services products. New data can be created on individuals’ personalities and their likely behaviour, complementing existing risk assessment processes to produce a rounder picture of an individual.The psychometric test can also be expanded to business loans, allowing more companies to start and expand.
Mobile lending as a litmus test for change
Smartphone and mobile money data can also be harnessed to open up the financial services sector to both individuals and businesses in Africa. As an example, Kenya has an intrinsic entrepreneurial spirit, from informal shops and roadside stores to sophisticated web-based start-ups. However, as with other emerging economies, a high percentage of Kenyan start-ups fail within the first three years of operations, with working capital identified as one of the main reasons for failure. Entrepreneurs who previously struggled to obtain formal finance due to a lack of credit history now have an opportunity to benefit from mobile lending solutions.
With the number of African citizens with access to smartphones increasing, start-ups have an opportunity to widen their customer base through a host of digital platforms, reducing the overall overheads, whilst being able to better manage their business, finances and inventory. Over the coming years, we’ll see various regions in Africa benefitting from the growth in mobile lending, with the result being those loan records being stored within credit bureaus.
The World Bank’s goal is that, “by 2020, adults who currently aren’t part of the formal financial system are able to have access…as the basic building block to manage their financial lives.” The road to universal financial inclusion might be peppered with hurdles, but these are hurdles that can be overcome, through collaboration, open-mindedness and a new approach to the credit risk management industry.
Financial inclusion isn’t just about financing businesses and, for the cynics amongst us, creating more debt. It’s about levelling the playing field globally, giving everyone access to the services they require and, ultimately, giving people the opportunity to lead a better life; a chance to climb out of poverty and into a society that is fair and creates ‘wealth’ in its many shapes and forms.