How alternative credit scoring is transforming lending in the developing world

Tala, a data science and mobile technology company, is enabling its users in East Africa and Southeast Asia to download an Android application that provides them with a new kind of credit score. The app gathers 10,000 data points for each customer, forms a financial identity for them within five seconds, and then uses mobile money or other payment gateways to send capital their way. “Our mission is to provide customers with choice and control over their financial lives,” Shivani Siroya, the founder and CEO of Tala, told Devex in an interview at the company's Santa Monica, California headquarters, where her team is currently exploring markets for expansion. Those who lack collateral are excluded from the formal financial system and cannot access loans largely because they cannot demonstrate their creditworthiness. A growing number of companies are responding to the exponential growth of mobile phone usage and the rapid escalation of processing power with new ways to turn digital trails into financial track records. This new approach to consumer risk assessment can reduce the risk of lending and the cost of borrowing, but it remains to be seen which of the organizations tackling the challenge will move the needle from disrupting the industry to transforming it by redefining and democratizing credit scores in developing countries. “Disrupting the high cost of credit assessment and verification is a fundamental piece of unlocking full financial inclusion for underserved consumers across the emerging markets,” said Arjuna Costa, a partner at Omidyar Network. The Silicon Valley based philanthropic investment firm recently came out with a report, “Big Data, Small Credit,” that explores how algorithms and big data analytics are allowing companies to use social media activity and mobile phone usage to identify, score, and underwrite credit to low- and middle-income consumers who lacked a formal credit history. “In order to capitalize on this opportunity, there is a need for a concerted industry effort to build an ecosystem in which these enterprises can continue to develop,” he said. The idea of using digital trails to provide financial track records was pioneered by Lenddo, which launched its operations in the Philippines in 2011. The company, which uses algorithms that analyze social media and therefore is limited to consumers who have access to those networks, has since expanded to 20 countries. Other companies have used other aspects of mobile phone usage to assess creditworthiness, drawing on data like call duration or text frequency, which can be generated by any mobile phone. For example, people who organize more than 40 percent of their contacts by both first and last name are more likely to be good borrowers, Siroya said. It is important to contextualize this “daily life data,” as Tala calls it internally, which includes other factors like the language, profession, or mobile device of that individual. Grammar or punctuation in a text message or the time of day that people call their friends are called “features” which are put into models that determine credit scores, said Matt Flannery, the co-founder of Branch. Like Tala, Branch allows users to install an Android app that allows them to apply for a loan and get immediate access to funds via their mobile wallet. While Branch processes data points ranging from GPS data to call logs to social network data, Flannery said he sees financial features, such as how much money people have in their M-Pesa wallet and what other loans they already have, as being more useful than social features, like the way people interact on Facebook or LinkedIn. After launching in Kenya last year, Branch is now three months into its operations in Tanzania, where it put up an ad on Facebook and lended indiscriminately to the first 1,000 people who downloaded the app. Flannery and his team then waited to see which repayments came in. The default rate is projected to be at 25 percent, but Branch is hoping to bring that default rate down to 5 percent, as it did in Kenya. “There is a lot of information out there that can contribute to a credit model and is not being used,” said Tarek El Sherif, the founder of Zinobe, which is based in Colombia, where there is only 20 percent credit card penetration, leaving 80 percent of people to turn to the informal sector for credit. “If you want to tackle financial inclusion issues, then you need to update the existing paradigm.” Some investors who have typically steered clear of emerging markets have shown an interest in investing in these emerging financial technologies. For example, Chris Sacca, an investor in Twitter, Uber and Instagram, is also the lead investor for Tala. Their interest comes in part from the fact that mobile money is in a position to leapfrog the infrastructure of brick and mortar banks and startups such as Tala are in a position to potentially have major social as well as financial returns. “I needed to find the people who were going to understand this opportunity, understand how big of a problem it was and how we were going to scalably tackle it, and someone who would be with us for the long term,” Siroya said. New partnerships are forming around these new sources of data, including M-Shwari, a collaboration between the Commercial Bank of Africa and the mobile network operator Safaricom. The partnership demonstrates how mobile money services such as M-Pesa can be leveraged to offer a wider range of financial products, including insurance, at scale. It helped to inspire the recently announced partnership between the credit scoring agency Equifax and Cignifi, a big data engine that uses mobile phone behavioral data such as call records to assess creditworthiness. The new scoring system, which will be delivered online, will enable banks, retailers and insurers to provide credit to consumers in Latin America with no prior formal payments history. In order for this momentum to continue, policymakers and regulators must balance the need for consumer protection with the space for innovation to occur, said Omidyar’s Costa. Companies are still experimenting with algorithms, models and data sources. The key is for Silicon Valley startups and emerging market entrepreneurs to leverage their unique strengths, from capital raising to market knowledge, to develop the best alternative credit scores, said Kenneth Ngetha, the Kenya-based co-founder of Saida, an app that approves people for short-term loans based on their mobile phone activity. If they pay on time and prove to be responsible, these borrowers can escape the trap of the poorest people on the planet paying the highest price for loans, said Julia Kurna, founder of Zidisha, a peer-to-peer microlending platform. The growing number of ways to provide people with loans is putting traditional microfinance out of business by removing the intermediaries and bringing down interest rates, she said. “I spent ten years in microfinance and worked with local nonprofit organizations all over the world and at a certain point in time I got frustrated because they weren’t adopting the new technology available to them,” said Flannery, who is also the co-founder of Kiva, which he left to launch Branch. He told a story about meeting with borrowers in the slums of Lima, Peru. While they had Android phones and Facebook accounts, they were trapped in slower processes of lending that required group meetings and long applications. He realized he could remove the middlemen. By promising financial access anytime and anywhere, these new apps raise some concerns about the possibility of a predatory environment, said Carrie Keju, senior director of livelihoods at the international NGO Pact. “We need to be sure the populations we’re working with who are poor and financially marginalized are qualified to manage credit,” Keju said. “It’s very unlikely that for profit companies will be doing financial literacy for the poor, so we need to equip them to make for themselves the best opportunity from these innovations.” Whether these apps partner with lenders to provide credit scores that lead to loans, or transfer the capital themselves, it will be up to nongovernmental organizations and other third parties to evaluate the terms of these loans, ask what these companies do when someone defaults on these loans, and give consideration to their own role in consumer protection when the poor are spending money they do not have. 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