Indigenous Finance – Informal Credit Systems

How do low-income families which lack access to financial services historically get access to credit. Has technology made it easier for more people to access traditional financial services in Southeast Asia?

In less developed economies where formal financial services are not available to everyone, low-income families tend to establish their own financial services community to satisfy their credit and financial needs. Money Lenders are found in all societies and have historically been one of the most common ways to get access to credit.

However, low-income families may only have access to unregulated money lenders such as loan sharks, which offer credit with punitive terms. Regulated money lenders, although less stringent, require credit checks and other documentation which most low-income borrowers may lack. Other times, enterprises and wealthy individuals can also service low-income borrowers through various informal process.

Many of these informal financial systems predate the modern financial services. This article explores some of the traditional informal credit systems such as Pawnbroking, Book up, as well as ROSCAs (Rotating Savings and Credit Associations), which would be the main focal point.

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Pawnbroking

Pawnbroking had roots in ancient China and has been widely practiced in Asia and Southeast Asia. Pawn brokers lend money by using marketable assets such as jewelry, gold, and other household goods as collateral. When an item is pawned for the loan, the pawner may redeem the item back with the principal amount of the loan and some interest. The terms could be negotiated with the pawn broker. When trust has been established between both parties, favorable terms are sometimes offered by the pawn broker.

The marketability and value of the goods will be assessed by the pawnbroker before determining the loan amount. Pawnbroking has evolved with technology and some pawn brokers offer their services online. Pawners just have to describe and upload pictures of their item to get an estimate within minutes. Logistic partners will then pick up the item and pawners will receive their money via bank wire. This provides a convenient way to get access to short-term cash needs.

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Book up

Book up is a form of credit that exists pre-dominantly in Australia and is the only source of credit in remote communities. Book up is an informal credit offered by stores or other traders. It allows people to get goods or services and pay the stores later. Historically, many stores or traders practice unethical means to “secure” the book up debt, such as holding on to consumers’ bank passbooks and PINs. Other times, the stores might charge the consumer a fee or more for goods that are booked up. The terms of the agreement are usually based on the lender’s discretion. ??

The system of Book up credit is similar to modern Buy-Now-Pay-Later (BNPL), which utilizes similar concept of getting the goods first and paying them at a later period, only this time in a structured periodic manner. It is not surprising to realize that modern BNPL actually originated from Australia. BNPL is practically the modern Book up system to help consumers get short-term credit. BNPL has effectively innovated, digitalized the book up system and adapted it to our physical and e-commerce stores. ?

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ROSCAs (Rotating Savings and Credit Associations)

Perhaps the most popular financial system that is used in many developing nations is ROSCAs or Rotating Savings and Credit Associations. ROSCAs have been used for centuries in the developing countries across Africa, Asia, and Latin America. ROSCAs usually have a different name in the different communities that they are found - called Arisan in Indonesia, Chit funds in India, Committee/Kameti in Pakistan, Hui in China, and Stokvel in South Africa, etc?

The basic mechanism of ROSCAS is nearly the same everywhere around the world. A group of people, usually organized by friends, relatives, and neighbors forms together to gather for a series of meetings. Everybody will contribute an agreed amount of savings to a common pot. Typically, one member of the group will be selected at random to receive the pot of savings. Subsequently, the members who have received the pot will be excluded from the selection process but still contributes towards the pot. This process will be repeated until everyone has received the pot i.e., their money has been paid back.

ROSCAs function as a bank of sorts for these communities. For people who got the pot early in the cycle, it is equivalent to an interest-free loan, while getting the pot at the end of the cycle could be seen as a savings mechanism. In other words, it gives people who don’t have access to emerging financial systems a localized financial system that they can use.

Within ROSCAs, there are a few variations depending on the country and community. For example, some parts of India and Pakistan practice a type of ROSCAs called a “chit fund”. An auction system is embedded into the selection process of the pot winner. For example, a ROSCA with 10 members has a pot containing USD100 for that month. If someone is willing to auction the pot at a lower amount, say USD91, and wins the pot, the excess (USD9) will be split amongst the other 9 members. This allows the people who need access to credit urgently to get the loan first, albeit at a small cost.

ROSCAs could also be formed for different purposes such as for groceries, party, family, insurance and investments. Traditional ROSCAs is usually not a formalized system with no laws and regulations to govern it and is largely based on the trust and strength of the community. Hence, ROSCAs are susceptible to conman and defaults by members.

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Digitization of ROSCAs

ROSCAs are commonly regarded as a social and cultural importance for these communities and will continue to stay around. Various Fintech startups recognized the value ROSCAs provide to the underbanked and are digitalizing the ROSCAs process amongst their communities.

Most notably, a women-led Fintech startup in Pakistan, Oraan, is paving the way to the digital era of ROSCAs. Oraan is a women-first neobank in Pakistan that is aiming to build a social bank through their digital ROSCA model. Without a community or a support group, it could be challenging to find a ROSCAs group within close proximity. The digitalized process allows women to participate ROSCAs outside of their social and geographical networks while preserving their anonymity.

To lower any risk of default and bad apples, Oraan has partnered with Credolab to assess the credit worthiness of these users using alternative credit data. A process which would be challenging in traditional ROSCAs settings. ?

Through digitalization, Oraan was able to overcome the limitations of traditional settings and layer additional financial products for their users. This has proved to be a major step in democratizing access to financial services and empowering underserved women in Pakistan.

As mentioned, ROSCAs can also be formed for different purposes. Tyms Africa, an African based startup, is spinning up a digital ROSCA that provides microcredit for micro-businesses such as mom and pop shops. StepLadder is a London-based startup that utilizes a digital ROSCAs system for users to be able to fund their house and deposit. It also allows members to connect to other relevant property service providers such as mortgage brokers and insurance, as well as group-buying discounts. MoneyFellows is another Egypt based digital ROSCA startup that allows members to be able to fund their durable goods and daily needs. On top of that, MoneyFellow adds new layers to their ROSCAs system such as product recommendations and facilitates the purchase like a BNPL tool.

Digitalization has allowed products and services to be layered on top of the traditional ROSCAs system, creating more value and convenience to the ROSCAs members.

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Alternatives to ROSCAs and Innovation Opportunities

Over the years, other forms of alternatives have been created to build on top of the ROSCAs system such as ASCAs (Accumulated Savings and Credit Associations) and SILC (Savings and Internal Lending Communities) within the community.

ASCAs system is a modification of the ROSCAs system. Instead of distributing the pot to the selected member, ASCAS do not give the funds to anyone. The gathered funds are instead lent to willing borrowers with interest. The interest paid on the loan are then accumulated and a part of this interest is distributed to the members at the end of the year.

SILCs are similar to ASCAs in that the loans are paid back with interest which are used to grow the fund. At the end of the cycle, the funds will be distributed back to the members in proportion to their total savings. SILCs are usually more attractive to participants than traditional ROSCAs system since it offers interest on members’ savings. ?

These alternatives/variations could present opportunities for Fintechs to digitize the process. Existing ROSCAs Fintechs could also introduce these alternatives system as an option for their users, creating financial solutions to a wider group of audience. Other developing countries with a substantial ROSCAs user base could also be seen as a market opportunity waiting to be snagged.

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Conclusion

The large unbanked communities around Southeast Asia is ushering the need for alternative finance solutions and innovation that could be seen experimented with indigenous finance models. Alternative savings and credit models that are rooted in tradition have the social appeal and informality that unbanked communities are more open to. As it develops, we are expecting companies to innovate along the several dimensions of such models that could synergize financial solutions to bring greater convenience, options and benefits to the underbanked population.?