Across the globe, there are an estimated 2.5 billion people who are “unbanked” or “underbanked.” This means that almost a third of the world’s population either doesn’t have a bank account or doesn’t have access to bank lenders or credit agencies. This makes it nearly impossible to buy a moped, invest in a business, or pay medical bills or tuition–and, ultimately, to rise out of poverty. Access to credit is as correlated to middle class status as perhaps any indicator.
Which is why microfinance, the banking practice of lending small amounts of money, has become an $81.5 billion industry. But as anyone who has watched the microfinance industry can tell you, it’s far from a perfect solution. Microloans come with high lending rates—on average 35%. One reason rates are so high is because it’s expensive for banks to evaluate lending candidates with thin a credit file or no file at all.
When I first began working with outsourced teams in the Philippines 10 years ago, my young and skilled staff often asked for loans. Although my employees and hundreds of thousands of other Philippine professionals earned middle-class wages, they lacked access to credit services that would allow them to invest in themselves and their families.
But while people may not have traditional assets, like houses or cars, they do have social assets in the form of friends and family connected by social networks and the Internet. My business partner and I saw the proliferation of smartphones and digital social networks as an opportunity—and in early 2011, we founded an online platform called Lenddo to turn this “connectedness” into proof of identity and creditworthiness. As of January 2015, we have hundreds of thousands members worldwide.
The idea that social networks can serve as underwriters relies on the theory that by understanding an individual’s community interactions, one can understand his or her trustworthiness. If this rings true, the next question becomes: How do you make vouchsafing digital? We designed an algorithm that would analyze a person’s social networking behavior—whom they connected with, how often, via what channels—and create a credit score that could predict a person’s repayment behavior. Applying these scores, we were able to screen out those likely to default and to connect trustworthy borrowers to the right amount of capital at the appropriate interest rate for their risk profile, through lending companies that, at first, we owned.
This impact was powerful. For example, one of our customers was the first in her village to go to college; her sister was the second. Most of the loans were and are used for education, smartphones, and family health care, and many dollars wind up back in the village, solving the “last mile” problem of getting economic development assistance to those most in need.
Between March 2011 and mid 2014, we processed about 100,000 loan applications. It was apparent that our risk algorithms were working and that the consistency of our ability to predict risk across countries, regions, products, and terms gave us confidence and credibility—and the data—to multiply our impact. After talking to financial institutions, online marketplaces, and cellular carriers, we came to three key realizations.
The first was that large financial institutions were now eager to serve the emerging middle class. But while bankers recognized the opportunity, they still couldn’t underwrite it in the absence of a traditional credit score.
Second, lenders faced an underwriting problem beyond credit scoring: costs associated with confirming the identity of applicants.
The third ah-ha was that organizations beyond banks needed to authenticate and credit-score their customers. Cellular carriers, with millions of customers, were eager to offer new credit-related services, such as financing small loans and the purchase of smartphones. Insurance companies, e-commerce firms, job sites, and Internet startups all saw an opportunity to profitably serve new segments of consumers, thanks to cheap capital and mobile banking. One new lender that has licensed our technology expects to process 80,000 applications every few weeks, a volume equal to three years of transactions when we flew solo.
Opening capital markets to the emerging global middle class is a win for both lenders and loan recipients. And there is compelling opportunity for doing it quickly. Aging populations in developed markets like the U.S., Japan, and Europe need to find a way to invest their collective trillions if they hope to maintain their standard of living in retirement. And hundreds of millions of young people in emerging markets are eager to finance their educations and upward mobility by participating more deeply in the global economy.