The world’s unbanked population hovers around 2 billion, a truly unfathomable number of people who rely on informal methods of capital acquisition that are often unreliable, usurious, and stress-inducing. In today’s post, let’s take a look at the concept of usury in emerging markets lending and understand why lending rates are so high — at least in relation to those in the US — what can be done to bring those rates down, and who is going to help us get there.
Lending to customers with little established financial identity, frequently referred to as “thin file” individuals, is an expensive proposition for lenders, which typically translates into an even more costly service for consumers. On a recent client visit to Mexico, we found that financial institutions — be it innovative, tech-enabled microfinance organizations or tier 1 banks lending down-market — tend to conduct extensive manual verifications and credit assessments for both new and existing borrowers. These operational expenditures drive nearly 60% of the lending costs for lenders in emerging markets. When prospective borrowers are too remote and disconnected from the financial grid, the verification requirements for the small loan amounts they need are liable to be either cost prohibitive for most lenders to undertake, or the costs are transferred onto the borrowers through elevated interest rates. Consequently, as Mehrsa Baradaran notes, “one of the great ironies…is that the less money you have, the more you pay to use it.” Bottom line: customers who are both expensive to reach and whose information is not easily verifiable are facing loans with annualized interest rates of 80% or more.
With a massive push towards financial inclusion in Latin America — Mexico, for instance, recently launched its own National Financial Inclusion Strategy — financial service providers are looking for new ways to reach previously under or unserved credit markets. However, to achieve their goal at scale, the power of technology cannot be overestimated. The future state of financial services lies with those institutions able to tap into technology that not only provides better access to internal and external information, but also manages its availability from disparate sources in variable formats and marshals its value at different points along the customer value chain.
With years of experience developing software solutions to solve this specific market failure, we at DemystData are determined to fix this problem. By delivering a software that provides the right information about the customer at the right time, we are allowing our clients to streamline verification and credit assessment processes and reach new-to-institution customers in ways previously deemed too cost prohibitive. Whether it’s running effective marketing campaigns, verifying identities, preventing synthetic fraud or helping institutions make better credit decisions, we help bring information through a single platform to clients in a digestible format, enabling faster, cheaper, and more affordable financial services.
This future state may be driven in part by online lenders and other fintech innovators whose agile and risk-tolerant approach alters the way in which risk is appraised and credit disbursed. But banks will also be on the front lines with their distinct advantages of massive technology resources, lower cost of capital, and infrastructure to bring new products and services to scale. We at DemystData will continue to support and drive innovation for those institutions, large or small, whose offerings meet the growing demand of the world’s financially underserved.
By Matt Hennessy, Business Development