The business of microfinance is an expensive one. Providing small loans to the poor is a labour-intensive process that is fraught with credit risk. Micro financial institutions (MFIs) working in emerging markets have to deploy loan officers in large numbers to work with remote populations, often scattered across challenging physical geographies. And they have to do this using limited customer data.
In these conditions, generating business, scoring potential clients and processing loans and payments requires that loan officers work with relatively small customer pools, which increases operational costs. Overcoming this challenge has meant that MFIs have traditionally looked for ways to optimise their productivity by grouping their customers or by bundling certain services. It has also meant that interest rates for clients have been high.
Tech transformation
But technological innovation is changing the way MFIs are doing business. Markets in Africa are leading this shift thanks to the continent’s experience of mobile money, as well as its culture of innovation. In Kenya and Tanzania, where financial technology (fintech) developments have gone hand in hand with progressive regulation, the results are pushing down operating costs, lowering customers’ repayment rates and contributing to accelerated financial inclusion.
Developments in mobile technology have played an important role. As is the case with its conventional counterpart, microfinance is increasingly turning to mobile solutions to generate additional growth. This has affected the way in which MFIs gather, transmit and analyse data. By creating more efficient scoring mechanisms, through the use of larger data sets, MFIs are swiftly becoming more productive, and in doing so are scaling up their operations.
“Providing microfinance offerings to rural and remote communities generally leads to higher operating costs. But the effective use of technology, across the whole microfinance operating chain allows MFIs to extend their reach and serve smaller clients at a lower cost,” says Scott Brown, chief executive of VisionFund, the microfinance arm of development organisation World Vision.
Though industry veterans are optimistic about the future, most are keeping a grounded perspective on these developments. For one, mobile- and data-based innovations present their own set of operational challenges. Teething problems are also expected as these new systems are deployed in the field. Moreover, most MFIs recognise that a reliance on technology must not undermine all-important personal relationships between the customer and the organisation, a bond which forms the bedrock of the industry.
“Despite these technology advancements, we must not lose the client touch. Once you lose the client touch and you’re just taking information in and putting it through a scorecard then you lose the ability to understand that client,” says Mr Brown.
Pace of innovation
For now, however, innovation is occurring at a blistering pace. For its part, VisionFund is pushing hard to lower its operating costs by improving the way it aggregates and uses customer data. According to Mr Brown, VisionFund aims to allocate about 500 customers per loan officer, though in markets with more dispersed populations this number can go down to between 200 and 300. Yet, the hope is that through technology investments the productivity of individual loan officers will increase, a trend that will help VisionFund to expand its presence in the most remote corners of the markets in which it operates.
“We have invested in tablet technology to increase the productivity of our loan officers. Using tablets, our staff can input information relating to a client's financial and personal data and send this through to our mainframe where the information can be scored and a loan approved. It’s high speed and low cost,” says Mr Brown.
“We have a premise that our costs should go down in our branches by 30% to 50% because our productivity is going up. If this proves to be accurate, we can move a lot faster into rural areas because our costs have dropped.”
This virtuous cycle of cost reduction and market penetration, especially in remote and underserved areas, is leading to greater financial inclusion. It is also formalising much of the grey economy in markets where the government is in need of an expanded tax base, and where underserved sectors such as agriculture have much to contribute to economic growth. Beyond the benefits linked to financial inclusion and economic development, these trends also present a compelling business opportunity.
Fintech frontiers
With growing frequency, fintech firms are now gaining a foothold in Africa’s microfinance sphere. The application of advanced technology to the microfinance operating chain is not only proving commercially lucrative but is having profound implications for the way that these MFIs do business. In November 2015, MyBucks, a Luxembourg-based fintech firm, acquired six banks from Opportunity International, a global MFI, across sub-Saharan Africa.
The deal was unique in that it represented the first time a fintech firm had acquired the operations of a microfinance operator. In doing so, the two organisations are hoping that combining knowledge of mobile and digital banking of MyBucks on the one hand, with the client base and network of an established microfinance player such as Opportunity International on the other, will augment financial inclusion and yield improved operating results.
In a similar vein, Finca, one of the world’s leading microfinance institutions, signed a partnership agreement with New York-based fintech group First Access in May 2016, to establish the largest alternative microfinance credit scoring system in the world. First Access will assess Finca’s existing client information, as well as data sourced from local mobile network operators (MNOs), to provide enhanced client credit scores.
“The microfinance industry developed before any consumer data was available in emerging markets. To get around this, MFIs used joint liability in local communities to ensure that loans were repaid rather than lending on an individual basis,” says Nicole Van Der Tuin, chief executive of First Access.
Driven by data
But with an increasing trend towards lending to individuals, MFIs have had to adapt the way in which they do business. In the past, most MFIs did not offer risk-based pricing and instead provided a flat interest rate to their clients. Not only was this expensive for those taking out micro loans, but it also failed to encourage the kind of financial inclusion that MFIs set out to achieve. Today, improved data sourcing and analysis is offering a remedy to this situation.
“What we have learned is that the source of the data doesn’t tend to matter. First Access started out using mobile phone data but we realised that MFIs can make use of their existing, archived data in new ways. What’s more important is the quantity and quality of the data and the way in which it is analysed and scored,” says Ms Van Der Tuin.
First Access therefore works with existing lenders with extensive historical data. The company then combines this information with new sources, including a customer’s mobile phone data provided by local mobile operators, and creates an algorithm tailored to the market in which it is operating. By adopting this approach, Ms Van Der Tuin says that the company looks at a specific institution’s historical data and uncovers inefficiencies while improving the long-term performance of an MFI’s lending activities.
“In countries such as Nigeria and Kenya, there are growing numbers of digital lenders. You are starting to see a lot more digital activity and the adoption of new technology that is bringing down the costs of doing business,” says Ms Van Der Tuin.
Too big a risk?
Nevertheless, this technology boom has not been without its casualties. Given the low barriers to market entry for most tech firms, the learning curve can be steep. For a digital platform that is also in the business of lending, this means starting out from scratch with fresh data sets and the need to develop a workable metric to measure non-performing loans can be challenging.
“It’s easy to reach someone and give them a loan but figuring out how to make that process sustainable and to make it work over the long term, that’s the hard part,” says Ms Van Der Tuin.
Indeed, while technology is opening up new opportunities for growth for the microfinance industry as a whole, it is also presenting new challenges. Given that some MFIs are looking to automate the credit scoring processes of customer pools or segments deemed to be low risk, an approach that drastically reduces overall costs, it does raise questions about an institution’s willingness to lend to a customer with which it has a limited personal relationship as well as the size of the potential loan.
“Risk management in microfinance is difficult. How reliant can a microfinance organisation be on data-driven scoring cards? How much can they be prepared to lend to a client they haven’t met?" says Chris Low, managing director of Letshego, a microfinance provider with a presence across sub-Saharan Africa.
For its part, Letshego has not only outsourced the scoring process, but with it the initial lending activity for new clients. “Letshego intends to outsource the credit scoring of new clients, which includes their early borrowing cycles, to an external partner. After this time, we believe that it will be possible to predict with about 95% accuracy the client’s repayment behaviour,” says Mr Low.
Mobile moves
Beyond the use of data, MFIs are increasingly making use of mobile microfinance products and services by building on the success of mobile banking. In Kenya, a partnership between the Commercial Bank of Africa (CBA) and mobile network operator Safaricom has produced a market-beating mobile microfinance offer known as M-Shwari. Leveraging the success of M-Pesa, the mobile money product, M-Shwari operates as a unit of M-Pesa in which customers are offered combined savings and loan product at the micro level.
Customers open a bank account with the CBA through M-Shwari that is subject to standard regulatory norms. Once opened, they are then able to apply for micro loans through their mobiles. The minimum size of a deposit is Ks1, while the minimum loan size is Ks100. Loan applications are based on existing customer data, held by both the CBA and Safaricom. If insufficient data is in place, customers must wait up to a few months and exhibit creditworthiness through positive deposit behaviour. They are then scored based on M-Shwari’s unique algorithm.
Though M-Shwari is an example of a microfinance system being offered through a conventional mobile money, elsewhere MFIs are developing their own mobile microfinance offerings. Kenya’s Equity Bank has established its own mobile virtual network operator in order to launch Equitel, its mobile banking platform, by leasing a local MNOs excess spectrum capacity. Through its Equitel offering, Equity Bank is providing small and micro loans to its customers.
“Mobile microfinance has many advantages. When you look at mobile penetration in Kenya, it is very high. And it also helps to keep costs down,” says Paul Githinji, manager, head office operations, at Equity Bank.
Listening to the customer
But mobile microfinance offerings are only as good as the market in which they are provided. In Kenya and Tanzania, rolling out these products and services is made easier thanks to the history of mobile money in both jurisdictions. This means that regulators, as well as consumers, are up to speed in terms of engaging with new offerings. It also means that financial institutions and mobile network operators have more mature and co-operative relationships relative to other markets on the continent.
Above all, the success of mobile microfinance offerings comes down to the financial literacy of the end consumer. “There are a number of challenges linked to the rollout of mobile microfinance offerings. The first is financial literacy. It is important to ensure that new clients have basic financial planning skills and many microfinance providers, including Letshego, have mechanisms in place to support financial education,” says Mr Low.
In the end, these innovations, and others, can only help to spur the growth of the microfinance industry across Africa. By lowering costs and promoting financial inclusion, the real winners in this picture are the 2.5 billion unbanked adults living across the continent, as well as in Latin America, Asia and the Middle East. But as this revolution unfolds, microfinance operators must not lose the human relationships that have been the source of their strength and success to date.
“You can’t just make it all about technology,” says Mr Brown.
