Expert View: Social Underwriting Transforms Microcredit Access

November 4, 2015

A Financial Inclusion Week discussion with Premal Shah, Kiva’s president and co-founder, on how innovative social underwriting can transform access to affordable credit for those whom traditional microcredit leaves out

Kiva is a pioneer in crowdfunding. Founded in 2005, in its first decade it has mobilized $768 million from individual lenders investing in small business borrowers in 83 countries — nearly half the world.

With Kiva Zip, the company is transforming the number of microcredit borrowers who can access credit. Through its innovative social lending model, Kiva Zip can say yes to those whom traditional microfinance institutions reject based on credit scores or lack of multiple years of cash flow history. It aims to be the first rung on the credit ladder.

Similar to crowdfunding sites, Kiva Zip borrowers must recruit fifteen friends or family to seed their loan with at least $25 each. After they do that to demonstrate that the people who know them best view them as the creditworthy, the loan request is featured on Kiva’s site for public lenders. Unlike IndieGoGo, where as few as one in ten campaigns reach their funding goal, Kiva Zip reports that nine out of ten borrowers get their loan fully funded.

That’s because Kiva may be the perfect platform for crowdfunding: microentrepreneurs don’t have to recruit independently dozens of strangers to fund their project. Kiva already has an enormous community of people actively engaged in lending for social good, with a platform full of recycled capital ready to be re-lent.

Inclusion Hub spoke with Premal Shah, Kiva’s president and co-founder, about how social underwriting can include those excluded from traditional microcredit.

Inclusion Hub: Debates over microfinance’s utility have dominated the news in recent years. What’s its strength? What do we need to resolve?

Premal Shah: The debate around microfinance’s utility has centered on credit — less so savings and insurance. The question we all need to be asking is, how can microcredit be improved to better serve client needs in a scalable way?

Microcredit provides a lot of value compared to the alternative of informal sector borrowing at very high interest rates, say from a village money lender, but there’s a lot that can be improved to hit the sweet spot of sustainability and impact.

The role of microfinance is to expand the frontier of banks, and the role of Kiva is to expand the frontier of microfinance. Kiva is a non-profit that helps microfinance providers around the world innovate their credit programs to against their own risk and cost frontier. From where we sit, we see enormous opportunity to lever a small amount of subsidy to create large-scale improvements in credit delivery that affect millions.

Inclusion Hub: Kiva Zip loans are offered at zero percent interest. How are low interest rates powerful for borrowers?

Premal Shah: It’s really important to lower the cost of credit: if you can lower the cost of capital for a low-to-moderate income household, then their return on capital does not have to be as high in order for that to be a good decision on the part of the household. In other words, the impact of accessing a loan goes up if it’s cheaper.

The impact equation is your cost of capital and your return on capital? So if I borrow a hundred dollars to buy a cow, and the cow produces the twenty dollars in profit over a year but I’m paying forty dollars in interest over the year, that’s a bad investment decision.

It’s even worse if I borrow the money for consumption-smoothing: I’m not investing in anything productive and I’m just covering living needs I have; that’s important but that can be just much more expensive. My preference would be that people save instead of borrow. However, people don’t always have the daily income streams to save and put money away, and a well-timed loan can really be impactful—if the cost of that loan goes down.

That’s what I mean by expanding the frontier of microfinance. At Kiva, one thing we seek to do in the years and decades to come is really innovate around how to lower the cost of microcredit. The average microcredit interest rate worldwide is thirty-five percent currently. Can we help bring it down to something that’s sub-ten percent?

Inclusion Hub: How can the lending industry bring down microcredit interest rates?

Premal Shah: If you look at the cost drivers of credit, they break out into a few components. The first is the administrative cost of collecting and disbursing the money. The second is the cost of the loan underwriting; microfinance institutions’ process of forming groups in the joint liability model, or doing a cash flow analysis in the individual loan model. When you add up those two big cost drivers plus the cost of capital and leaving a reserve for losses, it’s very hard to charge anything less in the offline model of microcredit than what you’re seeing today.

I think if we can bring more of the power of technology to each one of these components, we can lower the cost overall. A clear example is what digital payments are doing around lowering the cost of collections and disbursements; that’s been well documented.

Kiva’s breakthrough in terms of reducing the cost of underwriting is that we have a new model where the borrower first has to invite fifteen people from their network to invest in them privately before they show up publicly on the website.

This model is scaling much faster than our U.S. model has historically. The reason why is that many of our borrowers who applied for loans historically in the U.S. did not have the credit score or two-to-three years of cash flow to get approved by one of our community development financial institution or microfinance partners in the U.S.

In this social underwriting model we now employ in Kiva Zip, however, the borrower, regardless of their credit score or cash flow, just has to bring in fifteen people who believe in them who are each willing to invest at least $25. That is shown to signal high creditworthiness for a starter loan of $5,000-$10,000. The repayment rate in the Bay Area, for example, now stands at about 93% on 400 loans, and it’s growing quite quickly.

We’re very excited about this idea of moving out of credit scores and cash flow underwriting to a character-based system where it’s the borrowers’ network investing in them that signals creditworthiness.

Inclusion Hub: Since Kiva was founded in 2005, the mobile revolution — the expansion of mobile phones and mobile financial technology throughout the developing world — has expanded almost concurrently with your own work. How have you seen this affect financial inclusion?

Premal Shah: The mobile revolution is powerful in so many respects. One, it certainly brings the cost out of the system by being able to get money there and back through mobile payment systems. Two, it allows access to crowdfunding to a whole new set of borrowers who, when we first started in 2005, were not yet online. Three, it gives people agency and control over their money in whole new ways. For example, if you’re a woman in Kenya you’re no longer necessarily storing it under your mattress where your husband may be able to take it from you, but rather it is on your own personal SIM card protected by your own PIN.

Inclusion Hub: What surprising differences — or similarities — have you seen between Kiva borrowers in the developing world and those in the U.S.? Running a small business is challenging; what motivates people to do this?

Premal Shah: The circumstances people are in, the types of work they do, and the reason they do it may be different. But the common quality I see across the entrepreneurs that I’ve met on the platform is that they have a hustle: they’re willing to put in the work make things better for themselves. I see people who have the fundamental belief that tomorrow can be better than today.

In the U.S., it’s sometimes about fulfilling a lifelong dream, while in the developing world it’s sometimes more about making ends meet. Regardless of circumstances, what I see across all the entrepreneurs I’ve met on the platform is that people tend to do it for their families and their communities: there’s a larger “why” there. Something I hear across the planet as well as here in the U.S. is the desire to help your kids have a better life than your own — it’s pretty amazing how motivating that is as a reason.

Inclusion Hub: Kiva is a crowdfunding pioneer. You’ve mobilized $768 million in 83 countries — half the world — from individual lenders. In what way do you think enabling regular people to be part of this is itself a form of financial inclusion?

Premal Shah: When more people can be involved, it builds empathy for people’s realities that oftentimes people don’t have a chance to see or feel, and it does it in a way that’s hopeful.

When you can focus on one person and read their story and follow their progress as a partner based on mutual dignity, it becomes much more manageable for people to get involved. That’s important. Partnership and greater empathy will fuel the rate at which we’ll see total financial inclusion.

In the photo: A food truck owner hands a credit card back to a customer after taking an order. (AP Photo/Jae C. Hong)

Published in partnership with News Deeply

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