By Michael Schlein, President and CEO, Accion Around the world, two billion people lack access to formal financial services. There’s no single cause for this widespread and significant problem, nor is there a single way to address it. But there are new trends in data, analytics, and mobile phones that we can use to remove some of the impediments preventing people from accessing and using formal financial services–particularly credit. In many cases, the principal barrier preventing applicants from borrowing is a fundamental lack of information about the customers themselves. Lenders reject potentially creditworthy applicants because they don’t have the detailed financial profiles that banks rely on in underwriting. These “thin-file” applicants–including first-time borrowers, legal migrants, and young adults–might be excellent customers, but lenders typically pass on them because they’re essentially invisible. That invisibility results from how banks typically do business. In the U.S. and many other parts of the world, banks generally rely on only one piece of information to make credit decisions: a credit report generated by credit rating agencies. These reports are built on the assumption that past credit behavior predicts future credit risk. This assumption is problematic for a number of reasons. First, to be able to build a credit score, one needs access to credit to begin with; and to access credit one needs a credit score. Second, credit agencies in different countries use different systems to evaluate credit behavior, so a profile created in one country might not be recognized in another. When migrants move legally to a new country, their credit histories–no matter how good they are–stay behind. A migrant who has already paid off a mortgage or a car is still “credit invisible” when they reach their new home.This is a problem even in countries with complex, integrated formal financial systems: in the U.S., one in 10 Americans have no credit history, and an additional 19 million have outdated, “unscorable” histories. There are millions more “thin-file” customers in the U.K., Spain, and Canada, who face similar problems in addition to the billions of other financially excluded people who lack access to any formal financial services and are invisible to the sector. This exclusion prevents entrepreneurs from launching businesses or parents from sending their children to school. It also costs banks quality customers.But data can change that. In the last few years, new solutions have emerged that leverage the explosion of personal data created by the proliferation of mobile phones to better understand customers and predict their credit behavior. Combining a wealth of alternative data–including social media, internet usage, phone records, and bill payments–with robust analytics can help lenders understand what the applicants themselves are like. That information can be much more valuable and predictive than credit scores. There are a number of innovative startups tapping into alternative data and using it as the basis for new lending models. In fact, some of them result from the very problems caused by banking’s overreliance on credit scores. When Aneesh Varma moved from the U.S. to the U.K., he couldn’t get a credit card despite having a strong financial history. His experience motivated him to co-found Aire, an alternative credit scoring startup that uses applicant-provided information and new sources of data to verify customers’ identity, profession, education, lifestyle, and financial knowledge. Aire uses this information to help “thin-file” customers and creditors work together. Other companies demonstrate a great deal of creativity using alternative data to predict user behavior. Tiaxa tracks users’ phone usage and evaluates them on 70 different variables a day. It analyzes whether users regularly top-up their air time, read and write text messages, travel frequently or use more than one cell tower, among many other behaviors. When a user runs out of airtime, Tiaxa uses this information to decide instantaneously whether to extend them a small amount of credit, a “nano-loan”, to talk on the phone, text, or surf the web. Though these “nano-loans” don’t represent much money, they can be essential to the user in the moment and the beginnings of a personal credit profile. The company is now starting to expand their service, using client data to make bigger working capital loans.There’s also Konfio, an online lending platform that uses innovative credit algorithms and alternative data analysis to help small businesses in Mexico that lack access to credit obtain affordable working capital loans; and Tienda Pago in Peru, which works with distributors of large consumer goods manufacturers to provide “mom and pop” store owners with short-term working capital loans that they need to buy more inventory and increase sales through mobile platforms, all while building a formal credit history.Alternative data’s growth is due in large part to mobile technology: although 2 billion people lack access to financial services, 85 percent of the world’s population–or roughly 4 billion people–have mobile phones that are almost constantly transmitting, processing, and receiving data. In fact, as mobile phones and the internet continue to spread throughout the developing world, there will be increasing amounts of high-quality, user-generated data at companies’ disposal. In 2011, 2 out 3 people in the developing world had smartphones; by 2020, 4 out of 5 will. At the end of 2015, 3.5 billion people were using the internet–and 2 billion of them were in the developing world. The financial sector is only just beginning to discover alternative data’s potential. As alternative data becomes more available, and as its analysis becomes more accepted, I hope that lenders discover other uses that go beyond “de-risking” new applicants, such as helping customers manage their financial health or using behavioral science and well-timed “nudges” that prompt them to save. It will take thorough data analytics and a great deal of experimentation, but the value–for businesses and their clients–is too great to overlook. This article was first published in CIO Review.
By Diana Taylor First published by Emerging Markets magazine, April 8, 2016 Latin America’s financial institutions are microfinance and financial inclusion pioneers. Bolivia’s BancoSol was the first commercial bank focused on the base of the pyramid, helping establish a model that now serves 200 million people worldwide; in Mexico, Compartamos’ 2007 IPO remains the largest in microfinance’s history; and Peru has captured the top financial inclusion regulation rating for the last eight years. Is Latin America’s innovator status fading? With only hundreds of high-quality microfinance institutions (MFIs) in the region, the industry has rarely needed to compete or innovate; in North America, thousands of banks fight to win and retain customers, and a host of emerging fintech players makes that competition even fiercer. High-quality, independent MFIs focused on the base of the pyramid are already too rare in Latin America. And commercial banks are increasingly looking to acquire privately-owned MFIs and consolidate the sector further. In 2009, Scotiabank bought Peru’s Banco del Trabajo, and purchased Mexico’s Crédito Familiar in 2012. In 2014, Credicorp acquired a majority stake in MiBanco. These moves indicate microfinance’s successes creating scalable, well-governed institutions, but also pressure remaining MFIs to adapt, sell, or differentiate themselves. I hope it’s the latter. For too long, Latin American microfinance has been too risk-averse and conservative. That can’t continue. Latin American microfinance is a cornerstone of the effort to provide the world’s 2 billion financially excluded people with the tools and services that they need. It supports countless individuals and businesses, and should invest in, improve, or partner with fintech startups or other alternative financial services to secure its future. The most immediate way for Latin American MFIs to differentiate themselves is finally committing to fintech. While it’s taking hold in the region, Latin America lags behind Asia and East Africa in promoting digital financial services. Inter-American Development Bank (IDB) President Luis Moreno recently reviewed how Latin American and Caribbean governments had digitized government services in the Financial Times, writing that they should “make these investments now” to “modernize devices, improve quality of life and share the benefits of technology more equitably” to “create the conditions to foster enterprise and prosperity.” Governments have yet to act adequately on this. The future belongs to innovators. There are significant markets across Latin America that fintech can serve: in 2014, people throughout Latin America and the Caribbean received over $65 billion in remittances. Leaner digital services will continue forcing remittances’ costs down, and banks should find ways to capture some of that revenue through fintech, rather than watch apps steal it away. But the business case for supporting fintech is broader than one service. Fintech makes it possible to make better bets while reaching more markets with more products. By analyzing digital footprints, financial institutions can know their customers, understand their needs and confirm their identities. And by analyzing phone usage, social media, and other sources of Big Data, innovators can develop sophisticated profiles of the people who are left out of the current system. Today, these individuals are invisible; with alternative data and the algorithms to analyze it, we can make 2 billion people visible. The Internet of Things even makes it possible to create pay-as-you-go mechanisms that can dramatically expand markets and financing for services in remote areas. Apart from the business case, by innovating, Latin American MFIs can reaffirm their commitment to promoting economic and social development. Despite the considerable contributions that Latin American MFIs have made advancing financial inclusion, too many in the region are still left out of the world’s formal economy. Roughly 210 million people across Latin America don’t have a bank account. That’s too many people for a region that others see as an example for inclusive finance. Many MFIs throughout Latin America were created to promote access to financial services. It’s up to their boards of directors and staff to live up to this mission, rather than grow complacent. Fortunately, there are a number of ways for regulators, management, and investors to address these challenges and promote innovation. Regulators should follow the Economist Intelligence Unit’s Microscope, an annual ranking and review of 55 countries’ policy for financial inclusion. Created by the IDB, the Microscope helps regulators adopt effective legislation. During this week’s IDB-IIC Annual Meeting, policymakers should discuss the Microscope’s recommendations, and consider how to enable partnerships between MFIs and startups. These relationships benefit both: startups can use MFIs’ banking licenses, and through partnerships, MFIs can refresh their brands while reaching new customers. Management should harness technology, which can reduce the time, effort, and cost of enrolling and servicing clients. A recent study of MFIs’ usage of digital financial services found that institutions using technology in the field saw increased revenue as a result of enhanced efficiencies, cost savings resulting from the elimination of paperwork, reduced fraud, and improved client service. Shareholders should influence their investments to embrace innovation. By challenging management to pursue new opportunities, they can help ensure the future well-being of Latin American MFIs, and ultimately assist more people and businesses access and benefit from the financial services that they need to build better lives. Diana Taylor is the Vice Chair of Solera Capital LLC and Chair of financial inclusion pioneer Accion’s Board of Directors Read about our clients. This article is also available in Spanish and Portuguese.