Millennial Mortgages – Can AI deliver a human touch to home lending?

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Every year $25 Trillion in new mortgages are issued. Mortgage is perhaps the biggest investment decision consumers make in their lifetime. However, the mortgage process is inefficient, highly intermediated with many pain points and remained has so without too many disruptions for decades.  Low interest rates and squeezed margins define the current state of the incumbent mortgage lenders, who can hardly think of a better way of doing business. Two startups Habito in the UK and Better in the US are using AI to add efficiencies to different parts of the Mortgage processes.

Habito is a UK based startup that is the first to use Chatbots to address the Mortgage advisory/broker space. Habito’s Digital Mortgage Advisor (DMA) looks up details of a customer’s financial life (e.g. employment, salary and personal life plans) with real-time market mortgage rates to calculate an indicative monthly payment. The DMA explains the impact the customer’s decision will have on the mortgage numbers as a traditional mortgage broker would, but in a fraction of the time (average 10 minutes). Habito is founded by Daniel Hegarty, who was Wonga’s head of Product, and is backed by angels including Transferwise CEO Taavet Hinrikus, Funding Circle’s founder Samir Desai and Yuri Milner.

Better, a startup based out of New York led by Vishal Garg, have managed to address the broader mortgage process, right from advising them on the right mortgage option, using AI ofcourse, to funding the mortgage. They have hired the CTO of Spotify to help them with AI capabilities that would personalise the mortgages to the customer’s financial profile. Since their launch in 2014 they have managed to fund over $500 Million in Loans. Earlier this year Better raised $15 Million from Kleiner Penkins and Goldman Sachs that valued them at $220 Million.

"I'm sorry if some of the 'affordability' questions we're require to ask may seem inappropriate."

A JD Power survey earlier this year, found that 62 per cent of people under 35 who bought a home this year said they would use a mobile app for a mortgage application, if their lender provided it. The home buying process, which is meant to be a happy phase in life, often turns out to be traumatic, filled with uncertainties. We have seen some startup activity in the real estate/proptech space (Purple bricks in the UK), real estate transaction management (on Blockchain), and real estate valuations using IoT data monitoring. However, the major pain points in the mortgage process have been broadly overlooked.

Mortgage Pain

Better and Habito have managed to look at the Mortgage lending process and improved it through clever technology, processes and business model changes. Let’s look at a few example pain points within the traditional mortgage process.

Inefficiency #1: Customers looking to buy a property typically need to factor in a few weeks to get a letter of verification (called Agreement in Principle in the UK). This letter states how much the customer can borrow, at what rates and what the monthly payments would be. So if by chance a customer found a property that he would like to move quick on, he would generally be disadvantaged. Cash only customers always have an advantage in real estate transactions.

The Millenial Way: Better have approached this as a two stage process. The first stage where they get information from the customer, and tell them what products are available for them. This is done by proprietory AI algorithms similar to Spotify’s algorithms to provide personalized music. At the end of this process customers would have a verified pre-approval letter reviewed by an underwriter. Better claim this letter would be available in 24 hours from the time the customer has made the request. The second stage kicks in after the customer has found a property, where the mortgage economics revolves around the property.

Inefficiency #2: The process of choosing the lender involves a lot of variables, however, customers generally go with the lowest overall cost of the mortgage (including various fees, upfront monies and Monthly EMIs) for the best period. They often lack visibility and guidance on what would be better for them, a larger upfront deposit or a larger monthly EMI.

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The Millenial way: Better provide complete transparency in terms of what is good for a particular customer – a higher upfront payment, or higher monthly EMI. This would depend on how long the customer intends to live in the property chosen, which in turn would decide if the break even would occur within that period.

Habito takes an unbiased and a personalised approach to choosing mortgages depending on the customers profile. The AI behind it ensures that customers are at the heart of the mortgage recommendations.

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Inefficiency #3: Mortgages often come with various costs attached to them, which is primarily because there is a person behind the scene trying to sell and close the deal for the lender, and this person needs to get paid. Also, mortgage brokers often sell products that get them better commissions

The Millenial Way: Better mortgage has no hidden costs, and it is completely free of admin charges. Better employs staff who will unblock the mortgage process, and help people through it, rather than sales staff to close deals. Their loan officers never get paid commissions. That’s a much needed change.

Habito charges equivalent fees across all mortgages as AI algorithms don’t have vested interest (yet). This ensures the customer gets the best product suited for his needs, everytime.

Inefficiency #4: Mortgage lenders offer a rate, but very often during or just before the process of the application increase the rates. I know a few friends and colleagues affected by this completely unacceptable approach by Mortgage lenders.

The Millenial Way: Better mortgages offer full transparency throughout the mortgage process. The use of technology to hold all mortgage information centrally, and loan officers who are not incentivised to mis-sell products helps too.

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As a Better customer, you can stay on the mortgage process 24 X 7, all 365 days. If a customer wanted to progress quickly on a property over a weekend (day or night), unlike high street banks, they would be able to get the required approval letters. That truly feels like a Millenial way to Mortgages!!

AI is no human

These are some interesting stories of efficiencies being added to the Mortgage process and business model, through intelligent AI algorithms. However, I firmly believe AI cannot completely replace a human on a Mortgage or an Insurance conversation. If I were going through a home buying process, or an insurance claim for a car accident, I prefer to talk to a human who understands the emotions of the process and treats it with empathy. However, I believe AI can add efficiencies, make the process unbiased, and provide personalised insights through thousands of data points that the human brain can’t cope with. The human in this process will just need to be – humane.

The US mortgage industry is $8.4 Trillion in size, and the top four fintech firms offering mortgages do just about $1 Billion in funding. There is still a long way for these firms to go, but a ground up approach to mortgages, cool technologies, and of course a human touch throughout the process can definitely proivde a happier home buying experience for customers.

Arunkumar Krishnakumar is a Fintech thought-leader and an investor. 

Get fresh daily insights from an amazing team of Fintech thought leaders around the world. Ride the Fintech wave by reading us daily in your email.

China Face-Off America – Battle of Global Payments between Tech Titans

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Earlier this year Daily Fintech did a China week, and there were several interesting topics and key insights discussed. We analysed how the three Chinese Tech giants (Baidu, Alibaba and Tencent) have led the Fintech boom in China and what the favourable factors that helped were. However, over the past few weeks, we have had some developments with WeChat expanding into Europe, and almost as a reaction (perhaps not), Facebook ramping up group payments on messenger, Android pay collaborating with Paypal and more. We have Ant Financial’s bid for Moneygram and there is also a rumour that Whatsapp was ramping up to launch payments in India. That feels like a heated battle between Tech giants of the east and the west (really Chinese vs Americans, such a cliche) for Global Payments Glory. 

While we immerse ourselves in Fin and tech in the west, we often tend to forget that there is a whole new world out there in Asia that completely dwarfs what we have achieved in the west with regards to Fintech. FinTech financing in Asia-Pacific was almost US$10 billion in the first half of 2016, eclipsing the aggregate of North America’s (US$4.6b billion) and Europe’s (US$1.85 billion). WeChat sent 32 billion digital red envelopes over Chinese New Year in 2016 and 46 Billion in 2017. Paypal did 4.9 billion transactions in the whole of 2015 and 6.1 billion in 2016. This list could go on, but you get the point. The dragon really dwarfs the west!!

China Fintech

Stats aside, Chinese tech giants have had tremendous success in their local Fintech market. In comparison, Apple, Facebook, Google and Amazon (the Fantastic Four) have had mixed results in the west.

I am fascinated by what Alipay(from Alibaba) and Wechat (from Tencent) have managed to achieve in China. A good story about the growth of these firms is how WeChat created a highly localised product to compete with Alipay. WeChat had been lagging Alipay upto the launch of “Lucky Money” during the Chinese New Year of 2014. It combined the Chinese tradition of “Red Pocket” with conventional peer-to-peer transaction, and achieved huge success by adding a fun flavor of luck into its payment function. During the New Year holiday of 2014, approximately 10 million users engaged and bundled their bank cards, and 40 million red pockets were dispatched. In 2016 these numbers on WeChat further increased to 420 million, and reached a massive 8 billion that same year. Jack Ma called this strategy by WeChat the “Pearl Harbour Attack” on Alipay.

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Now, lets take a look at what the Fantastic Four have achieved in Payments.

Facebook, apart from hiring David Marcus (from Paypal) haven’t really had much joy with its payments business. Its payments revenue (for 2016) of $753 Million is tiny when compared to ads revenue of about $28 Billion. And the payments revenues were down 11% from 2015.

Google’s Wallet project didn’t go anywhere at all, however it had a much better uptake with its Android Pay. By end of 2017, Android pay is projected to have about 27 Million users. Android Pay have just agreed to integrate Paypal to it, which would mean customers can use Paypal through Android Pay.

Amazon’s “Pay by Amazon” has been a good story from the time it was launched. It has now 33 Million users which is almost a 50% annual growth from 23 Million users last year. Amazon managed to get its Wallet License in India last week (watch this space).

Apple pay has been the leader of the pack in the payments world. With about 84 Million users projected by end of 2017, Apple have so far done well in this space, however still lags behind Paypal.

All these numbers from the Fantastic Four are tiny when compared to the numbers achieved by WeChat and AliPay.

Alibaba have been quite active in expanding through acquisitions. Investment into PayTM in India, provides them a hold into PayTM’s 200 Million user base in India. However the most recent news on Moneygram is an ambitious step into the remittance market, and if the deal did happen (post all the drama), it would provide Alibaba a 5% share of the 600 Billion pound remittance market.

'The Americans aren't objecting in principal to a merger down the line as long as we build a Chinese wall to keep a couple of things secret from the Chinese.'

WeChat have more recently started global expansion into South Africa, set up its European offices in Italy and planning a London launch soon. While they are behind Alipay with their global expansion, their customer acquisition strategy has worked better (than Alipay’s) so far.

When I talk to innovators in India, I often tell them to create a simple solution to an existing problem without overengineering it. That’s generally true for most developing nations. There are ample problems to solve and a half decent solution can see massive growth if executed well.  In the case of China a few hundred million users went from Cash to Mobile Payments and it was a classic leapfrog moment. Most likely Alipay and WeChat wouldn’t see this again in their Global expansion adventures.

I believe they would have better success through acquisitions, investments and partnerships with key payment players in their target markets, rather than trying to lift and shift their business model in China elsewhere. I also think that the winner of the East vs West payments war would be decided by key battlegrounds in India, LATAM and Africa. If Alipay and WeChat could expand into these regions quickly, then the Fantastic Four would struggle to gain ground. However, you don’t write off the likes of Apple, Amazon, Google and Facebook that easily. Watch this space!!

Arunkumar Krishnakumar is a Fintech thought-leader and an investor. 

Get fresh daily insights from an amazing team of Fintech thought leaders around the world. Ride the Fintech wave by reading us daily in your email.

Yielders pioneering Islamic Fintech in the UK

In my previous posts, I discussed how Fintech with a social impact could be a viable business model. Would Financial Services and banking be viable if it got more ethical? Post recession, we have had regulations force good business practices within banks. Decades ago, with products, processes and policies driven by cultural values, Islamic banking has just done that – taken an ethical route to Financial Services. Yet, Islamic banks have struggled to compete due to those constraints. We may have just found an answer to make this system more competitive in Fintech. Yielders, a UK based equity crowdfunding provider, has just attained the first Islamic Banking certification and become the first FinTech firm in the West to do so. Yielders have developed a proposition that looks pretty innovative, pragmatic and competitive in a low yield environment. In the process, they might well have set themselves on a path to pioneer viable Islamic Fintech in the UK and possibly in the West.

Islamic banking in the formal sense has been around for well over 60 years. However, Financial institutions that comply with Sharia laws only manage 1% of assets globally. This has been attributed to some of the principles, which act in ethically regulating the business, hence make Islamic banking less competitive. The key principles are,

  • No Interest (Riba): Sharia compliant banks cannot charge interest on their products. This is because of the principle that the banks can’t charge someone interest because they had access to money that the clients didn’t. And money can’t create money, which will result in rich becoming richer and the poor becoming poorer. Lending can be only against tangible assets.
  • No Uncertainty (Gharar): Institutions have to be transparent to its customers on the products they are being sold. There cannot be an open ended or uncertain contractual relationship between a Sharia compliant institution and its customers. In the west, this is now being enforced, under Conduct based regulations.'...And in this dungeon we incarcerate the lowest of the low - the mis-sellers of P.P.I. schemes!'
  • No Gambling: This is clearly prohibited under Sharia laws. But this is not just about not lending to a casino business (Gambling). Products that are based on making money in an uncertain situation (Speculating) like derivatives (Futures, Forwards, Options etc.,) are also prohibited.

If the whole of the Non-Muslim world had followed the above principles, we wouldn’t have had a credit crunch in 2008. Now, following these principles come with various overheads.

Product Development: Islamic Financial Institutions (IFI) need to be more innovative than their Non-Islamic counterparties to remain competitive. In the UK, there are 5 Islamic banking entities, and only one of them provide products for retail customers, and those products aren’t competitive on returns when compared to high street banks.

Regulation and Standardisation: There is no central body to regulate and support IFIs as we have the FCA in the UK for banks. This ends up in a lack of awareness with the institutions that want to understand this space better. Also, interfacing between Islamic and Non-Islamic Financial Institutions is quite challenging without the standardisation of products and operational processes. Most IFIs self-certify with certain authorities or with a panel of experts in the field.

Liquidity: As a result of the above two points, there is poor liquidity for Islamic banking products, with low volumes and transactions. This is also worsened by inefficient back office processes that are yet to be upgraded to 21st century standards.

Innovation: Islamic banks are still trying to get into digital banking, when this has been well on its way in the West for almost a decade. Most records are still paper based, and information exchange is not automated.

'If there's one thing the British are famous for, it's talking about the banks.'

Yielders leads the way:

Most of the current challenges could be solved by thinking Islamic banking and its products ground up, which is what Yielders have attempted to do. Yielders, an equity crowdfunding provider, led by Irfan Khan proves Fintech could be an answer to most of the above issues. Irfan was born in the UK and has spent 15 years specialising in developing technology solutions within Banking. His passion to bring to light the principles behind Islamic banking, and make them work in a Western context was the driving force behind Yielders. Today Yielders is the only Western FinTech firm that is Sharia compliant.

Over the years, Irfan has seen and understood the challenges that IFIs have had in the UK and wanted to change the landscape. One of the key issues with existing IFIs in the UK has been that, they have only targeted the Muslim community in the country. None of the IFIs in the UK have a non-Muslim name for example. In his opinion, they establish themselves in the west with almost an acceptance that their products wouldn’t be competitive enough for the non-Muslim world, and they would play the “ethical-product” marketing route with their Muslim customers. Irfan has turned this approach on its head by establishing Yielders as a Western financial institution that complies with Sharia principles. This he believes would attract more Western customers who the traditional IFIs haven’t even bothered targeting.

The other fundamental issue with IFIs operating in the west was that they were “shoe-horning” their products to the western markets. Irfan is taking a ground up approach with a Fintech hat on. At Yielders he is able to be more innovative with his products as he has structured them to be compliant with Sharia laws. However, he doesn’t think this is possible in a traditional IFI (yet) that lacks the agility of a Fintech firm. As a result, he is able to offer competitive returns on his products that are currently focused on Real estate, and could soon be extended to ISAs, SIPs etc., Yielders currently offer up to 6% net yield (without leverage) plus capital appreciation. This is a very practical and differentiated proposition for middle class consumers in a low yield environment.

It also became evident during the interview with Irfan that apart from agile product innovation, innovative data sourcing/interfacing is needed to make back office operations more efficient for IFIs to run on a lower cost base. As the operational costs go down, products can be priced more competitively which will bring liquidity to the market. Fintech could also improve interfacing and interactions between IFIs and Non-IFIs through various API and data exchange technologies, and automate back office processes.

Several years ago when I was doing my business degree there was a session on corruption. The course material started with Anna Hazare’s movement in India against corruption, and pretty much went on to project corruption as a thing with the emerging markets. There was a challenge from a Chinese student, who asked the professor “why is corruption being projected as a problem in the developing world, when Billions got wiped out of people’s pensions during the Credit crisis in 2008. Isn’t wall street the most corrupt place?”. Something I have noticed in the West is that if something is legal, it’s considered to be right. No wonder business schools run courses on Ethical business practices. There are a few things that the banking world, driven by capitalistic ideals, could do to make it more principles/values based. And if done so, it would most likely look like Islamic Banking. A few more players in Islamic Fintech could spark a new wave of opportunities both in the West and in the Islamic world. Inshallah! (God willing)

Households to ditch the spreadsheet for the cloud

Most of us like to divide our lives squarely in two – home and work. But there is a growing number of financial consultants that are inclined to have you start treating your downtime more like your office time, so as to better manage your household budget and finances.

Thankfully that doesn’t extend to workplace jargon – well not yet anyway. Just imagine if when you asked your partner if they could pick up milk on the way home they questioned if that was on the grocery roadmap. Or if, when querying where your teenage daughter was going on a Saturday night, she asked you to park that question for an offline conversation the next day.

All jokes aside, there is merit in getting more business minded with our household budgeting efforts – we do tend to spend up large. According to the last Australian Bureau of Statistics Household Expenditure Survey, the average Australian household spends around $69,166 on general household living costs. Out of a total of pool of $642 billion spent by households, this includes:

  • $78.4 billion a year on cars versus $2.2 billion a year on public transport
  • $8.0 billion a year on beauty versus $2.0 billion a year on brains
  • $14.1 billion a year on alcohol versus $1.1 billion a year on tea and coffee

So in a world of cloud enabled accounting systems and financial API connectors, it should come as no surprise that cloud budgeting startups like myprosperity are now looking to help households ditch the spreadsheets in favour of their platform. Using real time data, in much the same way their accounting predecessors have done, they are seeking to empower homeowners to make better and more timely decisions about how to run their households.

The wind is clearly in their sails. Just this week the Australian based startup announced it had hired the former Australian CEO of Xero, Chris Ridd as it’s new chief executive. Also backing the platform is the well-respected MYOB founder Craig Winkler.

The company has raised an additional $2.5 million for its household financial data aggregation portal, pulling in everything from bank feeds to superannuation, credit card data and insurance policies for that, dare I say it, single household view. Seems it’s hard to get away from the jargon after all.

According to Business Insider, the company has 10,000 users and $15 billion of assets running through its platform, with Ridd quoted as indicating the company has plans to move into selected overseas markets.

I certainly think there is demand for this sort of product. A while back I actually considered using Xero myself to achieve a similar outcome, but with the platform catering to businesses, it didn’t quite fit what I was after, without considerable workarounds. But this however may just fit the bill. My household ones, at least.

Daily Fintech Advisers provides strategic consulting to organizations with business and investment interests in Fintech. Jessica Ellerm is a thought leader specializing in Small Business.

How digital cash is being used in Finland to help refugees

The best part of writing on consumer finance, is that there could be more drama to it than the other sectors within Financial Services. As I discuss socially impactful financial services with people, I frequently encounter the view that you can either have social impact or you can make a profit. It is viewed as a hard choice and a trade-off. I firmly believe that technology can be both socially impactful and profitable. The refugee crisis is bringing the kind of problems that we normally associate with the developing world, to our neighbourhoods in Europe and the rest of the developed world. However, a few Nordic startups are working with their governments to onboard the refugees into their society.

We talked to a company in Finland called MONI that is using pre-paid cards to help refugees get onto the ramp to being a productive member of society in their host country. Before getting to the details of MONI’s work, I would like to touch upon a research done by Tufts University on digital and financial inclusion.

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Research on Cashless Economies:

No discussion on cashless economies is complete without discussing the Nordics and their progress in this space. They have clearly defined the blueprint for going cashless by creating the ecosystem to do so. Based on the research conducted by Tufts University, there are two main drivers to identify countries that would benefit the most from going cashless:

  • Digital evolution and
  • Cost of Cash

The Digital evolution Index provides an overview of how mature the financial services infrastructure is and also more importantly the level of digital inclusion. This is because, financial inclusion becomes a lot easier if policy makers and industry leaders first focused on digital inclusion. Africa is a great example where mobile payments growth followed penetration of mobile services. The Nordics are the leaders in this space, where digital evolution has been exploited well by policy makers to drive cashless initiatives.

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The other factor that would optimise benefits when a country went cashless is the current cost of cash. Cost of cash is generally high where the banks have to take a lot of efforts in keeping ATMs stocked up and where the cost of access to cash is high due to the country being large like Russia, Australia or the US. Another factor that increases the cost of cash is the lack of effective governance around tax. For example, in India, the shadow economy was about 20% of GDP before the cashless drive kicked in late last year and that was about $500 Billion approximately. No wonder the cashless drive kicked in even though digital inclusion wasn’t as good.

The Refugee Crisis

One key point that we can infer from the research above is that, when the digital evolution/readiness is higher, the cost of cash can be proactively kept under a threshold, even in crisis. One of the largest crisis of our generation is that of the Syrian refugees. About 11 million people have fled homes and about 400,000 have lost their lives. There is help with funds pouring in from various parts of the world, and technology firms creating new ways for NGOs to collect donations. However, one of the key challenges for refugees is inclusion into the society they have moved into. One ray of hope in this space is the relentless efforts of the Nordic start-ups that have supported their governments in providing the refugees digital and financial inclusion.

It is important to understand the challenges that the refugees and the supporting governments faced. Most refugees don’t have identification that delays immigration and visa processes. However many of them are skilled enough to add value and are keen to work. Without work, some form of normal life, educating kids, and integrating into the society by contributing to it also becomes hard. Also, from the government’s perspective distribution of monthly allowances to refugees have been inefficient, insecure and expensive, thus making Cost of Cash pretty high. There couldn’t be a better situation where digital innovation could have helped the situation. I had an opportunity to interview MONI, a fintech startup who have been working with the refugees.

The MONI Story

MONI, a Finnish startup based out of Helsinki, focusing on digital payments have pioneered the cause of helping refugees by providing them and the Finnish government the ability to move to a cashless infrastructure. (Thanks to the team at MONI for accommodating an interview at short notice). Moni with good support from the Finnish Immigration Service have been able to distribute MONI prepaid cards to the refugees, thereby providing them means to manage their own accounts when they get their jobs and salaries. This wouldn’t have been possible with traditional banks where the KYC processes couldn’t have passed for refugees without identification.

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MONI’s accounts are customizable and their features can be easily switched on and off. This is particularly important as both the Finnish Immigration service and Financial Supervisors impose strict controls on accounts used by the refugees. MONI have also gone one step further and provided its user interface in Arabic, Farsi and Somali. This has now resulted in a super-efficient financial onboarding process for the refugees. During my interview with MONI, they also mentioned that refugees and the unbanked would be their key customers. They believe that by helping refugees into the financial ecosystem, they would not only be able to sell other products to them, but also create a huge customer base that are loyal to the MONI brand.

MONI are not alone in their efforts to help the refugees, and have support from other tech startups for the social integration of the refugees. In one of his interviews, Antti Pennanen CEO of MONI had mentioned that the people within the Finnish Immigration Service have been very entrepreneurial with a “lets do this” attitude, and have a genuine interest to integrate the refugees into the society. That goes to show how public-private sector partnerships can work like a charm when both parties are driven to create impact. MONI’s partnership with the Finnish Immigration Service is an excellent case study for countries that are aspiring for better financial inclusion after having cracked the digital inclusion challenge. If only we could have more MONI!

IOT Meets DLT and Blockchain meets M-Pesa in Africa

 

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Editor’s Note: Last week, Aunkumar Krishnakumar (Arun for short) wrote a great post about the effects of Demonetization on Microfinance in India. We liked it so much that we asked for more and this week Arun has found two amazing stories from Africa. Both are practical uses of leading edge technology to change the lives of millions (for example to enable crop insurance for farmers). The technology used forces one to think again about some conventional wisdom. One uses a mix of Internet Of Things (IOT) and Distributed Ledger Technology (DLT), without using any Blockchain. Another uses Blockchain but with M-Pesa (not with Bitcoin or any Altcoin). Following our theme of “first the Rest then the West” we would not be surprised to see innovation like this coming to the West soon.

From next week, Arun will join our other Authors as a regular. Please see our announcement later today.

In the last few years, every time I visited India, I have got excited looking at the number of frictions and inefficiencies in day to day transactions. There were problems that could be solved to create huge impact to large communities of people. Of course, when executed with a good business model, those could be great stories creating social and monetary value. When I was talking about this to my friend from Nigeria a few days back, he mentioned that he had the similar thoughts about Africa, the continent with 54 countries, truly a land of infinite possibilities. Over the last few years, financial services driven by mobile penetration have created a few “leap frog” initiatives in Africa.

M-Pesa completed its 10th anniversary this month. It is the firm that revolutionised financial services by providing a simple way of transferring money, and has crossed 30 Million users across 10 African nations (only 10). But the impact it has created has already highlighted it as a model to be used for the emerging world.  In 2016, according to Vodafone, M-Pesa was used in six billion transactions. Research by Digital Frontiers found a 22% drop in female-headed households living in poverty in areas with access to M-Pesa. The same study noted that the source of income for almost 200,000 women in rural areas shifted from the low-income, labour intensive agricultural sector to more prosperous small business creation. However, there is a lot more to be done through financial inclusion and I believe Blockchain will be a key catalyst in unlocking the potential of this great continent.

Micro-Insurance for Farmers:

In my previous post, I discussed the challenges Microfinance had in improving farmers’ lifes in India. While researching for that, I came across instances where farmers who had insured their crops and lost them to drought had serious challenges in claiming money from their insurance providers. This was primarily due to lack of understanding of complexities around what triggered their insurance claims and also due to the bureaucracy and corruption that existed in the system. Crop insurance is one of the most underserved industries in the developing world.

Typically Blockchain firms have two different exploratory routes to address pain points in the Insurance value chain. The first set of firms which are the more common one try to add efficiencies around instant reconciliation using distributed ledgers. The second set of Blockchain firms, re-imagine the whole structure of the business from scratch, and in some cases intend to create a new structure altogether. A Blockchain company Etherisc is working on crop insurance in Africa and across the developing world. They are trying to solve the problem using a methodology called “Parametric Insurance”. In this model, the insurance pay-out is triggered by pre-agreed set of simple triggers, which do not involve any middle men. The data that triggers the pay-out would be sourced automatically by the system which will disburse payments according to pre-programmed rules. The other advantage is that this model offers crop insurance for one or two dollars a month, which is typically not economically viable for a traditional insurance provider.

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For instance, a farmer can insure his crops against lack of rainfall for a particular year. Etherisc would have a rule that if the rainfall for that region in Africa doesn’t cross a particular threshold, the pay-out to the farmer would happen automatically. From that point, Etherisc would source rainfall information automatically from the weather data base, and if the threshold is breached, the pay-out happens. There is no need for human intervention to assess claims or damages, there by keeping the process simple, transparent and efficient. More importantly, the farmer receives timely help, without having to go through the trauma of dealing with corrupt bureaucrats to get the payment. Etherisc are also working at integrating their product with M-Pesa to plug into the existing payments infrastructure in Africa.

Micropayments Ecosystem:

In most developing nations penetration of mobile phones and internet has been better than penetration of traditional financial services and the underlying infrastructure. The main reason that there is so little private or public effort to extend financial services infrastructure into these remote and often impoverished areas is that the cost and benefits don’t add up positively. This leads to hundreds of millions of people scattered across Africa with almost no infrastructure and thus little opportunity of changing their circumstances. The solution is to take a decentralised approach that the traditional financial services infrastructure hasn’t managed to achieve.

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IOTA is a lightweight crypto-token that is designed to facilitate micropayments. IOTA is derived from the acronym IoT which means Internet-of-Things. IOTA could be connected to millions of devices and could facilitate micro transactions between the devices by paying miniscule amounts to each other in a frictionless manner. IOTA is a completely new distributed ledger innovated from scratch. Unlike the Blockchain, it contains no blocks. They instead have developed something called a Tangle, which is a form of directed acyclic graph. Here a user sending a transaction verifies previous transactions through a small amount of proof-of-Work. This means that the verification of the network is not decoupled from the network’s users, as is the case in blockchains. Hence there are no external parties to be compensated, which means that IOTA got absolutely zero fees on transactions. I have painfully resisted the temptation to get too technical about IOTA’s tangle, but for those who like a good technical read, their whitepaper is here.

Due to this architecture, IOTA can be used for most business models that require a scalable ledger with no-fees. And this is especially interesting for micro payments that flow through an ecosystem of connected devices. The IOTA-Tangle infrastructure doesn’t need internet and can operate on Bluetooth as well.

A simple example highlighted by IOTA:  Business A set up a solar electricity instalment and sell it per watt in real time to business B, which is a company that saw the potential in selling sensor data to be used to optimize agriculture, so now business B is selling soil and weather data to business C which is an analytics company that turn the data into useful information that it sells to business D which is a farming company that use the info to optimize their crops. Of course, all of these companies buy their bandwidth from business E which saw the need for connectivity between these other businesses. A completely self-sustaining and scaling business ecosystem that might previously have been impossible because the profit margin was non-existent due to fees. A micro insurance model could work like a dream on such an ecosystem, a friction-free economy of things.

Unfortunately, expansion of such business models in Africa, is not going to be as friction free. Between 2010 and 2017 internet penetration in Africa grew from 10% to a mind boggling 27%. And in model countries like Kenya, this has reflected in the GDP growing as a result. However, there are challenges around how security of these Blockchain infrastructures are going to hold and how regulations would evolve around these disruptive initiatives. The other key challenge is awareness, where most people still struggle to understand what the value of a Blockchain based financial eco system is. However all is not doom and gloom, as there are quite a few initiatives across the continent educating people about bitcoin and Blockchain, and the demand for such programmes has never been higher. Onwards and Upwards!!

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Arun is a thought-leader specializing in how technology is changing consumer financial services around the world.

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Effects of Demonetisation on Microfinance in India

microfinance

This is a guest post by Arunkumar Krishnakumar, who is deeply involved in the early stage Fintech scene in London but was raised in India. So he is highly qualified to write about this important and controversial topic.  

Muhammad Yunus, who was awarded the Nobel Peace Prize for founding the Grameen Bank and pioneering the concepts of Micro Finance, said:

“I did something that challenged the banking world. Conventional banks look for the rich; we look for the absolute poor”

The Micro Finance industry, despite being hailed as a saviour of the poor, has had a turbulent ride in many parts of the world. There have been various incidents in the emerging markets where farmers have committed suicide when they haven’t been able to pay off their debts. As a result, the industry was regulated in some parts of the world, and institutions offering Microfinance had to adopt different credit strategies. While the focus of many of these institutions have moved away from achieving volumes to offering affordable micro-credit, the global average rate of borrowing is about 30%.  Micro Finance in India has been no different and has had its ups and down. The recent Demonetisation (DEMON) drive in November 2016 looks like a setback to the primarily cash based Microfinance industry.

Microfinance in India:

In India, pioneer Micro Finance Institutions (MFI) operated as non-profit, non-governmental organisations with a strong social focus. They developed new credit techniques; instead of requiring collateral, they reduced risk through group guarantees, appraisals of household cash flow and small initial loans to test clients. In recent times, MFIs have transitioned from non-government organisations to nonbanking finance companies (NBFCs). As a result, once primarily donor-led, MFIs are now increasingly funded by banks and private and shareholder equity.

The Indian Micro Finance industry hit its peak in 2010, when SKS Microfinance, one of the industry leaders had its IPO. Muhammad Yunus, hailed as the father of the industry, criticised the move as the IPO was fundamentally conflicting with the principles of Micro Finance. The IPO offered at $350 million was 13 times over-subscribed. But due to reckless lending and strong-arm collection tactics that followed, strict controls were imposed on the business and loans written off which resulted in a slump. However, over the past few years, regulation of MFIs has been centralised in India and the industry growth stabilised. By 2016 the size of the industry in India was about $8.2 Billion serving over 40 Million customers. About 40% of this industry thrives in the four southern states of India.

In a country traditionally notorious for lack of women empowerment measures, MFI has been a shining light. About 70-80 per cent of the customers are women with a repayment rate of about 95 per cent against repayment rates of about 70 per cent for middle class men who form the primary borrowers for commercial banks.

DEMONetisation

In November 2016, the Indian government launched a huge DEMON drive when they banned 500 and 1000 Rupees notes. In a country where 69% of the population lived in rural areas and 90% of the transactions are cash based, the move was paralysing. For the Micro Finance industry this came as a blow too. Most of the borrowers of the MFIs are based in rural areas; they borrow in cash and repay in cash. Typically, MFIs that have had a repayment rate of 99% have had a fall of upto 12% in repayment rates. For many MFIs the non-performing assets (NPA) have risen by 7-10%.

For a discussion of the impact of DEMON in India please go to this thread on the Fintech Genome.

What does this mean for the MFIs? It might just be a short term blip, rather than a long term trend. However, these MFIs could be affected by the DEMON drive, and the resulting non-payments by their borrowers. While the borrowers will have some negative effect on their credit scores, it might be a bigger issue, if that affected the credit worthiness of the MFIs themselves.

What does this mean for the borrowers? Particularly farmers and SMEs that make up most of the customers are affected in a big way. The drying up of liquidity that the DEMON drive has caused has affected cash dependent rural communities in a big way. Especially in the southern states of India, the drought this year has made matters worse. In Karnataka, about 800 farmers committed suicide in the 12 past twelve months due to the drought and mounting debt, although what percentage of that is due to pressures from MFIs is unknown. In TamilNadu, my home state, farmers-suicide due to debt issues is almost a daily occurrence. There have been several cases where farmers have had to borrow from local lenders at higher rates, to pay off the MFIs, as MFIs tend to be stricter on their debt collection dates.

What can be done about all this? While these are certainly tragic incidents, there are various avenues the government and the MFIs have explored and continue to explore. One positive outcome of it all is that, the top 8 MFIs in India that hold about 40% of the market share, have now been provided the small finance bank licenses. Which would mean they can have their own cash out points and the DEMON drive is very likely to increase usage of their accounts. MFIs have also been lobbying with the Reserve Bank of India (RBI) to extend deadlines for the usage of the banned currency notes and farmers have had some special exemptions to this extent. RBI has also provided MFIs with a further 90 days extension before classifying loans as NPAs, if payments were due in November and December 2016. There have been some signs of recovery in certain parts of the country where repayments had fallen immediately after DEMON. However, most industry experts expect that there would be a further increase in NPAs before the industry recovers.

While the industry shows every sign of recovery, the livelihoods of drought stricken farmers are still up in the air.

PS: I am a big fan of Narendra Modi and his DEMONetisation measures. However, these were some of the unintended effects of such a huge initiative in a land of 1.3 Billion people. The human cost is clearly terrible, yet we have not seen the final chapter in DEMON. If it leads in the end to a more efficient digitized Micro Finance industry, it will have a positive impact on the poor in India and will be studied by other countries facing a similar mission.

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