NextBillion – An Initiative of the William Davidson Institute at the University of Michigan

NextBillion – An Initiative of the William Davidson Institute at the University of Michigan

Step by Step Credit: Empowering the Unbanked through Progressive Finance

One of the most exciting and meaningful aspects of the fintech revolution has always been its promised ability to deliver financial access and opportunity to those who have historically been left out. And indeed, it’s working.

The Global Findex database publishes every three years and offers comprehensive insight into how adults save, borrow and manage money around the world. In 2014 the database listed two billion people who were unbanked, and by 2017 this number had improved to 1.7 billion . While still far too many, it’s exciting to see progress.

What remains to be achieved, however, is widespread, permanent change. The good news is: Not only is this possible, but everything we need to make it happen already exists. In fact, it might just be as easy as setting aside long-held assumptions about the role of wealth and income in establishing credit.

Credit In a Formal Economy

Most of us in the United States and other developed economies, myself included, built our unique financial persona in much the same way. For me it started with my first, student-friendly credit card in college. I had wise parents who recommended I use this credit card to buy my books, then use my cash to pay back my credit card. Over time these transactions yielded a positive credit history.

Fast forward to my first apartment: It required a co-signer, but coupled with my fledgling credit history, it allowed me enough collateral to also qualify for additional lines of credit with utilities, my first car and, eventually, a better apartment that didn’t require any one on the lease but me. Adding up the success of these smaller transactions eventually led my wife and me to the biggest one we’ve ever made – our mortgage.

Traveling along this common “First World” trajectory, I progressively built my credit without thinking too much about it. Financial institutions demonstrated they were willing to place bigger and bigger bets on my behavior, largely due to my predictability and the collective predictability of most of their customers.

Put another way, banks work with people like me to build credit on the basis of extremely common events that come about from very common needs: education, transportation, housing, telecommunications, utilities, etc.

From a quantitative point of view, my credit history is built on top of my payment history. As I continually consumed these common, financed needs, my credit history progressively expanded to contain upwards of 1,000 highly relevant data points. A lender with access to this data could have a pretty good idea of what kind of bet I’d be. In fact, without this slow build in the relationship between the lender and myself, whereby they offered me ever widening opportunities as I progressively proved my creditworthiness, I never would have worked my way up to owning a home.

Credit in Emerging Economies

This approach is far less common in informal, cash-based economies. Instead, fintech-enabled lending has trended toward emergency cash or virtual cash loans through the mobile phone. Through microlending, lenders presume a certain pool of responsible parties will help absorb the risk (the bad bets) for those who do not pay their loans back.

To achieve this, two things are required: 1) the responsible party must essentially pull themselves up by their bootstraps to turn an emergent loan into a progressive opportunity, and 2) in order to have broad impact, all unbanked individuals must find themselves in need of an emergency cash loan. This presumes a level of need in the developing world that isn’t always the case. Cash-based does not intrinsically mean cash-strapped.

What if the same principles which applied to my own credit journey could also be effective in emerging economies? Certainly these populations consume much of the same common goods and services I do. The difference, of course, is that as their economic transactions are predominately cash-based, there is no easy or systematic way to collect, aggregate and disseminate the necessary data points lenders use to assess creditworthiness.

Clearly, when viewed in this light, lack of financial access is not a behavioral or cultural phenomenon, it is a data infrastructure issue.

The Data Behind Building Credit

As chief data scientist at Juvo , a company that works directly with mobile operators to extend airtime credit extensions to previously anonymous, prepaid mobile users, I work with a team committed to providing unbanked individuals the experience of building credit, first for mobile services and then progressively toward greater financial opportunities.

The premise is that if payment histories on the basis of common consumption patterns or events can be recorded, collected and transmitted to financial institutions, much the way it was for me, then it is possible to build credit. Furthermore, as these individuals experience progressive financial access (just as I have through my life), they’ll recognize the benefit and continue to walk up a pathway toward greater financial inclusion.

To date, the bet has paid off. We observe extremely high payback rates, greater than 95 percent; rapid adoption, as much as 50 percent penetration within the first year of going live in a region; and – perhaps most interesting – the same rate of successful progression in financial behavior regardless of location, culture, wealth or income. To put it simply, individuals in cash-based societies are eager and willing to demonstrate the exact same rate of creditworthiness their peers do all across the world.

Unbanked does not mean unbankable

This insight is profound. It means the acceleration of economic activity in the developing world is far more tractable from the progressive finance point of view, and all it requires is the appropriate data infrastructure, the ability to aggregate transactional data and a willingness to absorb the initial risk. Fortunately, mobile operators can play a critical role in providing the necessary infrastructure and seeding the financial transactions – just like the credit card company did for me with my college textbooks.

While microlending h as undoubtedly impacted intense poverty and provided opportunities in emerging economies , there is an important, almost philosophical distinction in progressive finance. If lack of credit really is just a data infrastructure problem, then, from a financial and economic behavioral standpoint, there is no difference between the child of an Indian farmer and the child of a venture capitalist in the heart of Silicon Valley.

In other words, in a very important and fundamental way , we are all equal. Certainly, this idea has been well-formulated from a civil perspective. But as an economic principle, it is a radical reimagining of the status quo which holds the key to successful and sustainable financial inclusion.

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