Underwriting the underbanked... an alternative approach

Banking the underbanked is big business. Two billion people worldwide are considered ‘unbanked’, lacking access to a bank account or credit card, and even more than that are seen as 'underbanked'. This is a lot of at-risk families, say NGOs; this is a lot of untapped revenue, imply others. Apart from anything else, lacking access to banking impacts the market heavily. Being unbanked effectively prohibits this huge proportion of the world’s population from entering the global market as consumers; those without access to credit or banking are left unable to purchase goods or services online or at a distance. However, the transition from unbanked to banked is often fraught with difficulties for both consumer and bank: customers unfamiliar with banking protocols may not trust the idea of making deposits, and banks might similarly doubt their new clientele’s “bankability”. How to resolve this two-pronged issue? Solidarity lending In 1976, a Bangladeshi economics professor called Muhammad Yunus began working on an unusual remedy for the latter issue: the lack of trust extended to potential borrowers by lenders. He founded what would later be called 'Grameen Bank', a banking institution that offered small loans, a.k.a ’microcredit’, to formerly unbanked members of rural communities in Bangladesh. Under normal circumstances, formal lenders demand good credit history or collateral from loan applicants, rendering many of the underbanked ineligible. However, Grameen’s 'solidarity' lending model required neither. Instead, self-selected groups of five borrowed as individuals but were mutually accountable for each other’s loans: if one member defaulted, the others received no further credit. Although joint liability was not legally enforced (as with, for example, cosigners), the resulted peer pressure encouraged timely repayments: in effect, the group's social capital served as collateral. Since Grameen’s entry onto the scene, group lending has attracted decidedly mixed reviews. Critics find microcredit in itself ambiguously effective, and encouraging 'social sanctions' morally dubious. In fact, following an epidemic of loan defaults in the late 1990s, Grameen Bank underwent a remodel which included adopting “flexi-loans” to minimise blossoming tensions between borrowers. However, while the attendant threat of group 'collusion to default' can complicate evaluative results, advocates point to historically impressive success rates. Emerging markets Using social capital to determine a borrower’s capacity for repayments - or trustworthiness - clearly works. But this success rests on tapping existent community bonds, especially for inside info on creditworthy peers. Such networks are dispersed in built-up areas, and face-to-face contact is costly and inconvenient. How to help the urban unbanked, especially in emerging markets? One solution: social media. 'We're not bankers... We're technologists', says Richard Eldridge, co-founder of Phillipine company Lenddo. Normally painted with the broad brush of a 'big data' lender (like ZestCash, Neo or the less illustrious Wonga), Lenddo began life as a loans provider with a difference: Facebook. The company’s proprietary algorithm mines user’s online data (including their social media profiles) for “trustworthiness ‘virtues’” derived from factors such as what a consumer’s interests are and how they interact with their connections. This information is then used by the algorithm to generate a score indicating whether they are likely to pay back their loans. Targeting a underbanked, credit score-less demographic, these readings help determine an alternative credit rating. Lenddo has now branched out, or rather, branched in; the company no longer offers loans itself but is selling its screening algorithm to a host of other companies in need of such rich data. Its logic is particularly useful in emerging markets, where a burgeoning middle class is in need of credit but likely to lack credit or banking history. And, although some might balk at the legal or ethical ramifications, Lenddo boasts low default rates and beats informal, risky alternatives. Plus, it’s a pleasing inversion of the 'recommend to a friend' mantra. Here, your friends recommend you.