Discussions about digital credit default rates have critiqued the "how" it gets delivered, but an alternative view is to blame "what" is being offered and conclude that more diverse and useful DFS are needed sooner. The digital credit so far in the form of the uniform, very small amount nanoloans aren’t delivering a strong enough value proposition in meeting specific needs to rank them high in a person’s order of expenses to cover and debts to repay.

How do we know that improving value propositions of DFS hold promise as a solution to defaults? Looking to two markets whose mobile money ecosystems have had more time to develop credit products can provide clues.

In this post, I'll compare digital credit in Kenya and Tanzania. CGAP’s research reveals <a href="https://www.cgap.org/sites/default/files/publications/Working-Paper-A-Digital-Credit-Revolution-Oct-2018.pdf">Tanzania’s default rate is 31 percent, almost 3 times higher than Kenya’s</a>. Why do these neighbors have such drastically different default rates? Apart from other <a href="https://fsdkenya.org/blog/four-differences-and-five-similarities-of-digital-credit-markets-in-kenya-and-tanzania/">distinctions</a>, two differences embedded in the research are:
<ul>
 	<li>Kenya has diversified the range and number of products on the market.</li>
 	<li>Tanzanians consistently preferred to use informal sources rather than digital credit.</li>
</ul>
Compare the data from the graphs below, from "<a href="https://www.cgap.org/sites/default/files/publications/Working-Paper-A-Digital-Credit-Revolution-Oct-2018.pdf">A Digital Credit Revolution: Insights from Borrowers in Kenya and Tanzania</a>," a CGAP/FSD working paper published October 2018.

Diversifying Digital Financial Services: A Way to Tackle Defaults and Over-Indebtedness

Kenya

Sub-Saharan Africa

Tanzania

Consumer Protection

Credit

Delivery Channels

Digital Financial Services

Informal Credit

Nano Loans

Over-indebtedness

Blog Post

<a href="http://www.fi2020progressreport.org/technology/"><img class="wp-image-19609 alignright" style="border: 1px solid #000000" src="https://centerforfinancialinclusionblog.files.wordpress.com/2015/10/fi2020-tech-section.png" alt="" width="615" height="336" /></a>The following post draws observations from the just-released FI2020 Progress Report on Technology. See the full report to explore other topics.

Technology innovation is dramatically changing the financial services landscape—and quickly. No longer are simple 2G/SMS-based payments the talk of the financial inclusion community. Instead, a range of platforms and products and services promise that as we move into the future, the costs of providing services will be lower, and the base of the pyramid will be within reach for mainstream financial services providers.

The world in which these innovations are mainstreamed is one where the agent network concerns we have today will be gone. In the cash-lite or cash-free world that technology providers are seeking, there will, in fact, be few to no agents, as people will receive money electronically and spend it electronically without ever converting it to cash. When is the last time you went to a banking agent?

Consider the following innovations that allow important financial transactions to take place without a detour through cash. (For a more comprehensive list of innovations, see the FI2020 Progress Report on Technology.)

Low-Fee Remittances: In 2014, the global average cost for transferring remittances was 8 percent – a burden for low-income families who rely on remittance income. But this may soon change. Start-ups such as TransferWise, WorldRemit, and Azimo have mobile apps through which users can send remittances at fees as low as 1 percent. Companies like PayPal are increasing their global consumer base, and charge 3–4 percent on international transfers. Customers who were recently offered mobile cross-border remittances in West Africa <a href="http://www.gsma.com/mobilefordevelopment/wp-content/uploads/2015/04/2015_MMU_Mobile-money-crosses-borders_New-remittance-models-in-West-Africa.pdf">responded by rapidly</a> adopting the service. Orange Money offered transfers between its own customers across Cote d’Ivoire, Mali, and Senegal, while MTN and Airtel created a bilateral agreement to serve the Cote d’Ivoire–Burkina Faso corridor. With the emergence of these competing business models, established players such as Western Union and MoneyGram have reduced their fees. Cornelis Heesbeen, CEO of Auxfin, a remittance service, <a href="http://www.remittancesgateway.org/index.php?option=com_kunena&amp;view=topic&amp;catid=9&amp;id=12&amp;Itemid=151">predicts</a> that by 2020 there will be no fees for remittances. The big question is how and when the remittance industry will shift from one in which most transactions start and end in cash at a banking agent, to one in which most transfers are account to account.

Pay-As-You-Go Utilities: Large up-front costs make solar home systems too expensive for off-grid, low-income customers, unless they get a loan. To sidestep the need for credit, some companies are using pay-as-you-go leasing technology on top of mobile payments. For example, with M-Kopa in Kenya and Mobisol in Tanzania and Kenya, customers pay daily-use fees via M-Pesa. If payment is not received, the company can turn off the system remotely through the embedded pay-as-you-go device. <a href="https://www.cgap.org/sites/default/files/DigitallyFinancedEnergy%20_FINAL.pdf">According to CGAP</a>, as of 2014 there were at least 25 companies selling solar systems with this technology in Africa, Asia, and Latin America. And the technology is being tested for other utilities, too.

P2P Lending: P2P lending services <a href="http://www.wsj.com/articles/peer-to-peer-lending-takes-off-in-china-1433320681">have taken off</a> and expanded rapidly, particularly in China, led by CreditEase, Lufax, China Rapid Finance, and DianRong. At the end of 2014 there were an estimated 1,575 P2P platforms operating in China, up from only 50 in 2011, and 103.6 billion yuan (US$16.7 billion) in outstanding loans issued via online platforms.

Online ROSCAs: An estimated 1.5 billion people globally participate in rotating savings and credit associations (ROSCAs). They provide a simple, informal method for people to save money and receive loans, although traditional ROSCAs can be unreliable and subject to management problems. <a href="http://kitty10.io/">Kitty10</a> is a mobile app that offers a possible remedy, allowing ROSCAs to manage their finances, maintain an electronic history of transactions, and easily make decisions (such as those dealing with loan amounts and repayment terms). It gives financial tips and can even build credit histories for members. <a href="https://www.margadarsi.com/index.jsp">Magadarsi</a> is an Indian chit fund that uses the Internet to support ROSCA-like operations. Magadarsi allows users to sign up online and pay savings and loan installments through online banking on its website. This allows for much larger scale in membership.

These innovations exemplify the impressive progress that technology has made in the last few years—and will continue to make from now to 2020, when the financial inclusion industry is striving to achieve financial inclusion globally. Truly, of all of the lenses through which we explored progress made toward financial inclusion for the FI2020 Progress Report, technology was the most promising, and we gave it the highest score on progress (7/10).

&nbsp;

Have you read?

<a href="http://cfi-blog.org/2015/10/01/rating-progress-toward-financial-inclusion-on-a-scale-of-1-to-10/">Rating Progress on Financial Inclusion on a Scale of 1 to 10</a>

<a href="http://cfi-blog.org/2015/01/08/the-twelve-days-of-fintech/">The Twelve Days of Fintech</a>

<a href="http://cfi-blog.org/2015/04/24/fintech-for-fi2020-a-conversation-on-aligning-technology-and-partnerships-for-financial-inclusion/">Fintech for FI2020: A Conversation on Aligning Technology and Partnerships for Financial Inclusion</a>

&nbsp;

Toward an “Agent-Free” World

Financial Inclusion 2020

Financial Inclusion 2020 Progress Report

Agent Banking

Credit Provision

Enabling Environment

Financial Technology

P2P Lending

PayGo

Payments

Remittances

Trends

&gt; Posted by Amy Jensen Mowl and Ben Sprung-Keyser, Institute for Financial Management and Research (IFMR), Chennai and Harvard College

There is revived interest in the role of informal credit in India, with researchers using a variety of <a href="http://eprints.lse.ac.uk/38369/1/ARCWP42-Fischer.pdf">innovative tools</a> to study informal products and their <a href="http://www.ifmr.ac.in/sefc/publications/Business-Logistics-of-Informal-Lending.pdf">delivery channels</a>. While the majority of informal loans may come from professional moneylenders, such lenders are not the only source of informal credit for micro and small entrepreneurs. Indeed, for households, non-bank credit is provided by a wide range of players, including moneylenders, unregulated pawn brokers and chit funds, employers and local shopkeepers, and caste and kin networks.

Interested in the range of alternative informal credit options available to businesses, we decided to take a fresh look at informal credit products in a major wholesale fruit and vegetable market in Chennai. The result: we found a market for alternative finance that revolved around merchants associations and the provision of common credit.

Two Associations, Two Loan Products, Two Outcomes

Amongst the collective loan products we examined, those offered by the Tomato Wholesaler Welfare Association (“tomato association”) and the Banana Merchant Welfare Association (“banana association”) were most notable. Like most voluntary trade associations in India, both associations function to protect and advance the common business interests of the members, share information, provide mutual assistance, and distribute gifts during festivals and ceremonies.

In addition to these basic functions, we found that the associations had credit and savings features, with mixed results. In the case of the tomato association, the individual wholesalers had devised an intricate mechanism for the collective pooling of resources amongst 50 members. All wholesalers who wish to join are required to pay a 10,000 rupee deposit and contribute an additional 50 rupees a day in membership fees. This financial arrangement lasts for five years, and so members are not permitted to withdraw their contributions before that time lapses. Instead, wholesalers in need of funds may borrow from the group at a rate of three percent per month. The tomato association deducts a small amount of interest income for operating costs and divides the interest income equally among individual members. One wholesaler explained that he had accumulated more than Rs. 200,000 in interest over the course of the last four years.

The banana association comprises 120 members who pay an annual membership fee of Rs. 1200. For a time, the banana association provided loans to its members at a rate of 2 percent per month.¹ This was initially designed as a system of mutual assistance. However, the banana association members we spoke to claimed that some members took advantage of the system. Realizing that the association would be reluctant to use the harsh enforcement tactics of professional moneylenders, some borrowers slipped into loan delinquency and default. Rather than continue to lose money, the merchants association stopped lending to all its members.

In addition, the banana association belongs to a larger association with flower and vegetable merchants. This larger association of 450 retailers previously provided assistance for members to receive formal bank loans. The association helped arrange documentation including tax returns, attested to the creditworthiness of borrowers, and helped confirm that borrowers had no outstanding credit obligations. In order to maintain credibility, the association was serious about only endorsing legitimate candidates. This process, however, created antagonism amongst the members. Merchants with poor credit histories began to approach the association demanding assistance. They felt that the selective provision of loan assistance was unfair. Rather than risk internal division and discord amongst members, the association simply stopped helping members receive loans.

[caption id="attachment_13839" align="aligncenter" width="580"]<img class=" wp-image-13839 " style="border:0" alt="" src="http://centerforfinancialinclusionblog.files.wordpress.com/2014/01/table.png" width="580" height="352" /> Key Institutional and Credit Product Features[/caption]

The financial products presented here give a fuller sense of the landscape of informal financial products available to small and micro-enterprises. Along the spectrum of financial services, we’ve found “self-organized” associations that attempted to design explicit rules for improving financial access for their members. The failure of the banana association to continue these services for its members illustrates some of the common problems of organizing and sustaining small financial institutions, and challenges of product design.

The persistence of informal or semi-formal credit at high rates of interest is a puzzle, as both of these groups appear to be segments that could be served by formal banks. Members of both groups have access to simple deposit services, and in the case of the larger fruit and vegetable association (450 members) have worked with banks to provide credit referrals. If these businesses are linked to the formal banking establishment, why are they choosing such high-interest loans over formal bank loans? Are they simply ineligible for formal credit, or are the contract terms of formal finance unattractive, even at drastically lower interest rates?

The simple answer given by the banana association for the failure of its loan product—that borrowers took advantage of the association’s goodwill and unwillingness to enforce harsh sanctions—is at best a partial explanation, especially in light of the success of the tomato association. Other potential explanatory variables include the presence or absence of a deposit and lock-in period, size and timing of recurring fees, number of members, repayment terms, profit-sharing terms, and other management features. Further research on the contract features and institutional design of informal credit products will help to test and further develop theories underlying key assumptions about the causes of formal financial exclusion.

[1] Professional moneylenders in the same market provide (1) daily loans ranging from 6-10 percent interest, payable per day, to (2) fixed-term 100-day loans at a rate of 10 percent of the loan amount, deducted in advance.

*This fieldwork was conducted as part of an ongoing study of the contract features of informal credit products

Have you read?

<a href="http://cfi-blog.org/2012/08/17/an-excellent-resource-on-regulating-client-protection-ifmr-trusts-blog-series/" target="_blank">An Excellent Resource on Regulating Client Protection: IFMR Trust's Blog Series</a>

<a href="http://cfi-blog.org/2013/05/28/layering-financial-inclusion-informal-on-formal/" target="_blank">Layering Financial Inclusion, Informal on Formal</a>

<a href="http://cfi-blog.org/2013/06/17/financial-engineering-for-low-income-households/" target="_blank">Financial Engineering for Low-Income Households</a>

A Fresh Look at Informal Finance in Chennai

Eric Noggle

Senior Research Director 

Chris Wolff

Sonja Kelly

The majority of Kenyans have mobile money accounts; their activity demonstrates digital financial services’ potential. Accion helps Kenyan innovators harness emerging technologies to create new financial services.

Amy Jensen