Understanding alternative credit models and managing risk

Currently, around 66% of sub-Saharan African is unbanked. There are two main reasons for this: (i) the traditional credit assessment models often don’t provide an accurate depiction of an individual’s credit worthiness, and (ii) traditional credit models do not work – for example, the individual or business lack collateral, or can’t commit to scheduled capital repayments. This, however, does not mean that these individuals are inherently unbankable.

Futuregrowth, as an institutional investor with a largely developmental focus, is exposed to several alternative credit providers seeking funding. Futuregrowth investment analyst, Melissa Moore,  shared two examples of alternative credit providers: Retail Capital which supports SMMEs’ working capital needs, and Small Enterprise Foundation which provides enterprise micro-credit to women in rural South Africa.

Retail Capital (RC) supporting SMMEs’ working capital needs

SMMEs are inherently risky, often having unpredictable cash flows. As such they have limited ability to commit to regular scheduled payments. RC therefore mitigates their risks by only providing loans to SMMEs with point of sale devices – i.e. they earn some of their capital through credit and debit card receipts. RC can then analyse the SMME’s transaction history, through the point of sale devices and, on that basis, calculate the companies average daily turnover. This amount is then used to model the amount of debt that RC believes the company can be lent. That amount, plus a fixed fee, is then calculated as a percentage of the company’s daily turnover. The loan is then paid over and recouped by RC through a percentage of the business’s card fees, until the full amount of the loan is paid off.

This method works well for the business, because when it is doing well, it pays off a large portion of the loan and, when it is not doing well, it is not burdened with scheduled debt repayments. It works well for RC because they are always first in line to receive their loan repayments, before money drains out of the company for other loan repayments and expenses.

Small Enterprise Foundation (SEF) funding women entrepreneurs in the informal sector

SEF funds women working in the informal sector in rural South Africa, using a group-based lending methodology. These micro-entrepreneurs have been funded by SEF for more than 20 years. SEF has managed credit loss rates at under two percent – far lower than Capitec which has loss rates of around 10%.

The model involves the credit assessment being undertaken by the people who know the community members best – i.e. the fellow community members. Women who wish to take out loans must organise themselves into groups of five. After an assessment by SEF, the group of women become eligible for loan funding, which they collectively guarantee. As such, each member of the group is collectively accountable for any loan taken out by another member of the group. Therefore, if one member of the group is unable to repay their loan, the rest of the group needs to step in to repay that member’s loan. The participants are therefore extremely selective over who they will allow to join their group and ensure that group members use the loan for the intended purpose, as opposed to squandering it. They also ensure that the group member pays the loan on time, in full.

A number of groups then form a ‘sector’. Any group that wants to undertake a loan, must present their case to the sector. The sector then decides whether to approve or decline the loan, resulting in a largely self-governing model.

In addition, SEF has a large branch infrastructure with field agents at each sector to support the women and to ensure that SEF’s policies are being adhered to. Another contributor to SEF’s is that each participating community member must take part in a savings and financial education training programmes. This improves participants overall financial health.

What makes a good alternative credit model?

In order to be successful in the provision of alternative credit, lenders need to have a unique value proposition involving an unserved group and building an innovative way to serve that group. Then the lender needs to test their solution, either through pilot projects or by building up a loan book slowly and responsibly. Furthermore, they need to understand the market and the type of client that they intend to serve.

The lender needs to have robust and appropriate credit scoring models to monitor loan performance and to adjust the credit scoring model as trends emerge. In addition, the lender must be able to achieve scale and be prudent in their provisioning.

IMAGE: Melissa Moore, Futuregrowth Asset Management

Article written by Damian Watson

Photo taken by Cobus Oosthuizen

2019-05-21T17:14:50+00:00 May 13th, 2019|Business in Society 2019, Uncategorised|