The Beauty of Inclusion, How Access to Finance is Changing the Landscape for Low-Income Entrepreneurs in India
Withdraw cash from an ATM, buy a bus ticket online, make a loan repayment at the bank. These are the seemingly mundane faces of financial inclusion, yet 2.5 billion people globally don’t even have a safe place to save money. Three quarters of the world’s poor don’t have a bank account, have no credit history, and aren’t eligible for any type of loan or financial assistance. In India alone 41% of the population is unbanked according to the Reserve Bank of India; in rural areas it’s 61%. Only 14% of India’s adult population has any sort of loan account, and 73% of farm households in rural India are excluded from institutional sources of credit. Being “unbanked means more than the inability to finance a car or buy a house. It stymies entrepreneurship, makes health crises catastrophic, and keeps the poor in poverty.
The Many Faces of Financial Inclusion
Financial inclusion has become a hot topic in the fight against poverty, and a variety of organizations have emerged to provide low-income communities with the financial tools and know-how to sustainably lift themselves and their families out of poverty. This robust network includes NGOs and nonprofits; government cooperatives; self-help groups, microfinance institutions, and credit unions. Some such organizations work off existing infrastructure to bring financial services to excluded communities. M-Pesa, for example, partners with telecom providers and utilizes mobile phone infrastructure to offer a technological alternative to conventional banking. FIA Global transforms trusted Kirana stores into banking centers providing otherwise inaccessible services directly to underserved communities. Microfinance giants like SKS and Grameen Bank provide small loans to community self-help groups, while other institutions like SAS Poorna Arogya Healthcare, provide basic insurance protection against health crises. Even commercial banks and insurance companies are reaching out in response to the Reserve Bank of India’s push to provide financial services to the “priority sector.” Venture capital funds, seed funding organizations, and angel investors are all taking on financial inclusion as a priority investment area. One such global investment initiative, Venture Lab, supports “innovative financial inclusion start-ups, fostering experimentation and promoting business models that improve financial access.”
In addition to providing protection and peace of mind to low-income families, access to institutionalized finance supports the growth of micro, small, and medium-sized enterprises (SMEs), which are, “collectively the largest employers in many low-income countries.” When provided with banking services, insurance, and other financial services, entrepreneurs can take risks and invest in their businesses, “spurring growth and reducing inequality…aided by integrated and universal financial systems.” Although access to financial services is not the panacea for poverty across the developing world, responsible finance is a powerful tool for low-income, risk averse, vulnerable communities. Financial inclusion helps low-income families, otherwise powerless to the whims of weather, money-lenders, and illness, “build assets, manage risks,” and create sustained sources of income for themselves and their families.
The Benefits of a Crowd, Financing Small Businesses and Building Livelihoods
For an aspiring entrepreneur in rural India, not only is credit prohibitively expensive, but without a credit history or collateral, getting a loan can be extremely difficult. Crowd-funded microfinance, pioneered by global institutions like Kiva, has provided small entrepreneurs an alternative way to access finance. Similar to the start-up savvy crowd-funding platforms like kickstarter.com and indiegogo.com, Kiva uses an user-friendly, online platform that connects funders all over the world with entrepreneurs looking to finance businesses, pay for school, and invest in other livelihoods requirements. Kiva partners with microfinance and field organizations to manage loan dispersal and repayment. Funders can re-lend their money after Kiva receives loan repayment from the entrepreneur.
Following the success of the Kiva model, Rang De, has taken up the peer-to-peer lending model to provide affordable microfinance to rural entrepreneurs in India. Potential lenders visit Rang De’s online platform, where they can peruse entrepreneur profiles and decide where to lend money. Rang De partners with field organizations on the ground to manage loan dispersal and repayment. Entrepreneurs are charged around 8.5% interest on loans, and are required to pay back their loan, plus interest, according to a set repayment schedule. Investors receive a 3.5% return on their social investment, and the remaining interest is divided between the field partners, a contingency fund protecting Rang De against defaulted loans, and Rang De, who takes a nominal 2%.
Since the site’s launch in January of 2008, more than 6,000 social investors have joined and the organization has impacted almost 30,000 rural Indian families with access to affordable credit. By utilizing an online platform—opening up the potential funding pool and working on volume—the cost of credit can be decreased dramatically. Through careful selection of field partners and local entrepreneurs, Rang De enables small investments to make large impacts on the lives of rural entrepreneurs in India.
The Search for the “Missing Middle”
Access to credit can be game changing for a small entrepreneur. As we’ve seen though, formal credit is hard to come by for low-income entrepreneurs in developing countries where financial institutions lack proper information to assess risk. To protect against the risk of default, banks and other formal credit institutions require proof of income, collateral, and a long credit history. These requirements exclude a host of aspiring entrepreneurs from growing their businesses. Though significant contributors to employment worldwide, SME employment in developing countries is remarkably low. This disparity, know as the “missing middle,” is due in large part to exclusion from institutionalized financial services.
Although SMEs have shown high returns on capital investment, financial providers struggle to identify “high-potential, low-risk entrepreneurs in a low transaction cost way” without the burdensome requirements that exclude so many from the financial system. Rang De has found a way around this by reaching out to individuals for social investment, but formal financial institutions find this task more challenging. The Entrepreneurial Finance Lab (EFL), an idea born out of Harvard University and funded by Google.org, offers an innovative solution to the problem of assessing credit risk among “unconventional” loan recipients. EFL uses a proprietary psychometric assessment with questions designed to gauge aspiring entrepreneurs’ values and beliefs, honesty, financial acumen, and problem solving skills. The 30-60 minute application is economical for the financial institution and has proven accurate as an indicator of loan repayment across countries and institutions without any need for credit score or collateral. Lending backed by EFL’s psychometric assessment sees a significant reduction in loan default, and EFL partner institutions are able to “triple their lending volume without increasing risk, tapping into new segments with little competition.”
EFL has processed more than 100,000 applications through their network of partner institutions, leading to 300 million dollars of additional funding being distributed to entrepreneurs across the developing world. By providing banks with viable alternatives to outdated assessment metrics and methods, EFL is helping previously excluded people, communities, and enterprises access the funding to grow businesses and economies.
As these financial innovations demonstrate, inclusion is a complex issue. Designing innovative models to deliver financial services means little if low-income communities don’t understand them. Building infrastructure to provide credit is limited if financially excluded communities are not eligible. In our next few posts, I will explore more of the complex issues surrounding financial inclusion in the developing world including technology, insurance, and financial literacy and education. India’s economic growth will be stifled if the 40% of excluded Indians are not allowed to fully participate in the growing economy. Brining these uneducated and vulnerable communities into the formal financial institution will be challenging, but the potential for impact is well worth the work. Much progress has been made, but there is still a long way to go.