How fintech and microfinance remove intermediaries and loan costs

Microfinance is a fabulous idea, but it has been hampered by infrastructure and distribution challenges and high costs relative to loan size, meaning that the world's poorest people pay some of the highest interest rates for small business loans.

In microfinance, interest rates of around 40% are common. For example, when a lender at Kiva, a website that allows microfinance banks to crowdfund lending capital, makes a zero-interest loan, the end borrower pays an average interest rate of 35% to cover the local intermediary's overhead costs. Such high costs make it hard for the borrower to profit from taking out a microloan.

This has been an intractable problem for decades. But in recent years, the spread of the internet in developing countries has made it possible for microfinance borrowers to go online directly. In Senegal, many of these internet-savvy loan recipients no longer needed loan officers to liaise with Kiva on their behalf.

Julia Kurnia is the director of Zidisha, a crowdfunding platform that lets ordinary web users lend directly to individual borrowers in developing countries, without any intermediary.

She told IBTimes: "The Zidisha story goes back to 2006, when I was volunteering in Senegal, helping a local NGO raise loans for people in rural villages through Kiva, a website that allows microfinance banks to crowdfund lending capital. There was a vast potential for entrepreneurs to grow their businesses and incomes through better access to capital – and an immense desire on the part of the lenders who funded the loans to help them do so.

"There was only one problem: since the loan recipients weren't able to use computers, they needed local loan officers to manage the loans and liaise with Kiva on their behalf. The administrative costs of supporting a loan officer-based organisation were so high relative to the loan amounts that we would have had to charge over 30% interest to be sustainable."

Effectively distributing microfinance is essential in developing countries where most people are self-employed, but it's very difficult for them to accumulate the large sums of money needed to invest in business assets like machines and inventory. Businesses tend to stay tiny and fail to generate the revenue needed to lift households out of poverty.

Dressed for success

Kurnia said one of Zidisha's first loan recipients was a seamstress who was originally sewing clothing by hand, producing just one or two dresses per week. A loan of about $800 (£610) allowed her to buy a sewing machine and inventory of fabric, and this increased her production to more than a dozen dresses per week. She ended up opening a clothing shop, creating a job for an employee and earning enough to send her nephew to college.

"Eliminating the local bank intermediary makes it possible for us to provide loans at a cost of just 5%. The low cost makes the loans a more effective way to overcome the cycle of poverty, because borrowers keep the profits from their loan investments instead of paying interest to cover a bank's overhead expenses," she said.

In order to keep costs low, the company employs no loan officers or any staff in borrower countries: instead, all services are provided online. This means not being able to conduct the in-person applicant vetting and repayment collection visits that traditional microfinance banks rely on to control credit risk.

"We've developed alternative means of controlling credit risk that are automated or outsourced to our users. For example, the borrowers themselves help with vetting of new applicants. Borrowers who have been with Zidisha for some time and have good repayment records earn the right to send a limited number of invites to trusted acquaintances. As long as the invitees maintain good repayment records, the inviter may continue to invite others. This creates an incentive to invite only reliable borrowers to join Zidisha.

New borrowers without a track record at Zidisha start with a tiny test loan, and earn the right to raise a larger amount each time a loan is repaid on time. Borrowers may opt to start with a higher credit limit by making a payment into a reserve fund. The reserve fund is used to compensate lenders for any defaults. Zidisha lenders don't earn interest, but the reserve fund makes it possible for them to maintain the value of their lending funds over time, said Kurnia.

"Borrowers post their project proposals on our website, along with photos and something of their own life story. Anyone with a credit card can visit our website and make a loan to one of the fundraising projects. Each project can be crowdfunded by small amounts from many lenders. Once the full amount is raised, we disburse the funds to the borrower.

"Loans are repaid to lenders in weekly installments. Lenders can relend the repayments, or withdraw them into a PayPal account. (We provide an optional automated lending tool that makes it easy to relend repayments.) Compared with donations, this is a great way to do high-impact philanthropy with limited funds. $50 put into a Zidisha loan fund, with payments recycled into new loans, finances on average $750 worth of projects in five years.

The platform allows lenders and borrowers to communicate throughout the course of the loan and share photos and updates on their projects, which keeps the lending process transparent.

Zidisha currently provides loans in eight developing countries: Burkina Faso, Guinea, Haiti, Indonesia, Kenya, Niger, Senegal and Zambia. In most cases users don't have bank accounts or ATM cards, and the service relies instead on mobile phone-based payment services, such as Kenya's M-Pesa, to send and receive loan payments.

Tax-deductable

Zidisha is a US-based nonprofit, but its lenders come from all over the world; around half are in North America, 40% in Europe, and the remainder in Australia, Asia and Africa. Since coming into existence in 2009, it has grown to more than 60,000 members and facilitated more than $6.5m worth of microloans.

The platform offers large tax-deductible donation lending accounts for high-net-worth individuals and charitable foundations. These are donations that are used exclusively to fund loans, with repayments continuously recycled into new loan projects.

Kurnia said: "We support loans of as little as a dollar, and most lenders contribute $50 to $100. That's about the cost of dinner in a US city, but it's enough to enable a single mother in Kenya to start her own restaurant!"