They have no bank account, no credit score, no financial identity. So a quarter of humanity hasn’t been able to borrow money. Until now.
Several dozen startups say they have developed ways to bring those 2 billion people into the international financial system, monitoring cell phone use and other personal habits to predict creditworthiness. For example, people who don’t let their phone batteries run low tend to do the same for their debt balance. Borrowers who get more calls than they make are better risks, and applicants who state their loan purpose in a few words are better borrowers than those who end up writing an essay.
While some of it may seem far-fetched at first glance, there are now 40 companies — some with backing from Peter Thiel and Pierre Omidyar — who say they are opening a new frontier. Their credit scores and loans issued via mobile phones across the developing world is driving down the cost for traditional lenders to sell financial products to an emerging middle class. For Wall Street, this translates into a new potential asset class to invest in: consumer retail loans in emerging markets, the engines of future global economic growth.
Social Media Use
“If any one of these models succeed, the ramifications are enormous for both the financial services sector and international development,” said Paul Christensen, a professor of finance at Kellogg School of Management at Northwestern University in Illinois. “A whole new market could open up.”
The companies say that phone use, web browsing and social media, utility payment records and psychometric tests all give lenders new ways to replicate, within seconds, the traditionally deliberate work of loan officers. Since phones are increasingly used to store and transfer money, they also carry a great deal of information about creditworthiness.
In essence, these firms say, the data measure what John Pierpont Morgan a century ago called the central predictor of creditworthiness — character. They are unlocking “unbanked” adults, most of whom are in emerging markets where annual consumption will reach $30 trillion by 2025, according to McKinsey & Co.
Kreditech, based in Hamburg, Germany, is the largest of the new companies and does not lack for ambition. It sees its future as the Amazon of consumer lending in emerging markets, said Sebastian Diemer, one of the two founders who is now chief executive officer. It has raised more than 306.5 million euros ($328 million) in debt and equity since its founding in 2012. Its financiers include Thiel, New York-based private equity firm J.C. Flowers & Co., and venture capital firm Amadeus Capital Partners.
First Access, a New York-based startup, mines data stored on Tanzanian and Kenyan borrowers’ mobile phones to recommend a loan amount to banks and microfinance lenders within 90 seconds. The proprietary algorithms can cut down clients’ underwriting costs by more than 92 percent, according to co-founder and CEO Nicole Van Der Tuin. Its backers include Capital One Financial Services co-founder Nigel Morris and The Social Entrepreneurs’ Fund, Bill Ackman’s venture capital fund investing in businesses that promote financial inclusion.
Some of the new companies have created their own surveys to measure reliability. EFL Global has designed a 30-minute test that doesn’t require Internet access yet can be taken on both mobile devices and computers. RevolutionCredit, based in Irvine, California, has developed puzzles and games that will test and then teach financial basics to loan applicants. Lenders subscribed to its service can then use the results to complement their applicant assessment.
A key to creditworthiness is personal daily routine. People who charge the same amount of airtime on the same day every week are better credit risks than those who purchase a large amount, then let their accounts sit empty, according to Van Der Tuin of First Access. When phones stay in the same place every day, that is often a sign that the owner is at work.
Moreover, in emerging market countries mobile phones are increasingly serving as ledgers of money movement. So monitoring phone records becomes a simple substitute for examining a bank account. At the same time, traditional credit risk assessments, according to the startups, have ignored the added importance of social capital. Beyond serving as de facto bank statements, mobile and online footprints indicate how well borrowers are treated by their community.
Jeff Stewart, founder and chairman of Singapore-based startup Lenddo, says one’s friends are predictors for creditworthiness just as they are for propensity to smoke, be obese or promiscuous. Kreditech’s Diemer added people are more likely to be better borrowers if they have friends who pay back their loans on time.
Lenddo’s patented credit score measuring social standing helped a Latin American lender halve the number of defaults, issue more loans and deploy more capital, said Stewart, whose investors include the Omidyar Network Fund. At the same time, much of the focus of these new companies is on the emerging middle class rather than the very poor since neither character nor social standing can make up for ability to pay.
World Bank President Jim Yong Kim in April launched a campaign to achieve universal financial access by 2020 and he has encouraged the new approaches of the startups. At the same time, the new companies are unlikely to replace traditional lenders or credit bureaus. Rather, they will probably complement them, said Alex Johnson, senior analyst at Mercator Advisory Group.
“It’s incredibly difficult to build a cross-market business from scratch that can replace the decades of relationships these traditional institutions have built with global banks,” Johnson said. “The pie is big enough for those established providers to focus in markets that are less developed than the U.S. and Europe but are still further along.”
The businesses will push lenders to evaluate applicants more comprehensively using a broader range of information, said Michael Turner, who founded the Political Economic Research Council to reduce credit invisibility around the world.
“The challenge is not one of technology,” Turner said. “The rise of big data has convinced network operators and other data furnishers that they are sitting on a gold mine.”
(A previous of this story was corrected in the seventh paragraph to show Peter Thiel’s investment was made through a separate firm.)