Sustainable Credit in Emerging Markets
Tomorrow Capital’s investment thesis is centred around supporting businesses that provide sustainable credit within emerging markets - but what exactly does this mean and why is it significant?
In emerging markets, the widespread provision of credit is a challenge; many people work within the informal economy (e.g. in India, 52.4% of total GDP is made up by informal sector activities1); workers in this sector often don’t earn salaries, and lack financial profiles in cash-dominated environments. Consequently, the traditional methods for assessing credit eligibility (such as yearly salary and previous financial history) break down. This is exacerbated by high transaction costs and non-inclusive financial infrastructure (many EM banks lend solely to major corporations), making it extremely difficult for individuals and SMEs to access the financial resources they need to grow and thrive. Worldwide, the MSME financing gap is estimated to be $5 trillion, with 45% of this originating within East Asia and the Pacific2.
Sustainable credit is a growing trend in emerging markets that aims to address the challenge of providing financial services to underserved populations in a responsible and sustainable way.
One of the key ways that sustainable credit achieves this is by using technology to better underwrite loans and make more informed lending decisions. This can involve leveraging innovative technologies such as mobile banking and data analytics to better understand customer needs and risk. For instance, Tala, a mobile banking and financial services provider that operates in emerging economies such as Kenya, the Philippines, and India, uses data analytics and machine learning to underwrite loans. For example, Tala’s microloan offering is evaluated on data from the borrower's phone, such as call logs, text messages, and social media activity, all of which are used to create a “digital credit score". This allows Tala to provide loans to borrowers who may not have a traditional credit history whilst mitigating default risk.
Another key aspect of sustainable credit is the removal of access to predatory loans. These types of loans (e.g., payday loans) tend to have very high APRs, and so can trap borrowers in debt cycles. Through effective underwriting, as well as the setting out of specific loan terms (e.g., short loan cycles, loans on the value of merchant products rather than cash loans), companies distributing sustainable credit can keep interest rates reasonable, thus protecting borrowers from predatory lenders and enabling them to build more secure financial futures.
Alongside the many startups finding cutting-edge solutions to the credit gap, The World Bank is also pioneering a global effort to improve SME credit access. Some of the ways in which they are doing this include:
- Financial sector assessments to determine areas of improvement in regulation and policy.
- Support in implementation of initiatives such as credit guarantee schemes.
- Improving credit infrastructure (credit reporting systems, secured transactions and collateral registries).
- Introducing innovation in SME finance such as e-lending platforms, use of alternative data for credit decisioning, e-invoicing, e-factoring and supply chain financing.
- Advocacy for SME finance at global level through participating and supporting schemes such as the G20 Global Partnership for Financial Inclusion.
The World Bank’s efforts have brought significant improvements to the credit gap; for instance, In India, their MSME Growth, Innovation and Inclusive Finance Project improved access to finance for MSMEs in three underserved segments: startups, services, and manufacturing. This was done through provision of a $500 million credit line to the Small Industry Development Bank of India (SIDBI), allowing them to provide an affordable longer-term source of funding for underserved MSMEs3.
Overall, the growth of sustainable credit in emerging markets is a promising trend that has shown great potential to improve welfare, economic growth, and the development of communities within emerging markets. By leveraging innovative technologies and business models, it has the potential to provide financial services in a more accessible, affordable, and sustainable way, and to help individuals/businesses in emerging markets build better futures.
Our Portfolio:
How do we translate this into our investing activity & decision making...?
Port Co’s such as Migrante are geography leaders in sustainable credit. Migrante uses technology in the form of an online marketplace & unique data point underwriting to allow financing for motorbikes, a key economic asset in LATAM. Consequentially, 92% of the current customers are immigrants who could not receive a loan elsewhere through traditional bank underwriting while Migrante retain market leading delinquency and 76% of customers go on to increase their earnings.
We continue to look for companies with unique sustainable credit practises across underwriting, pricing, collections & distributions.
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