Rethinking MSME financing: It's your customer's digital transformation that matters

Around the world and in Sub-Saharan Africa, the Covid-19 pandemic spurred an acceleration in digitalisation, as businesses and people shifted online to transact for goods and services. Meanwhile, banks and MFIs (microfinance institutions) have been engaged in their own shift to digital, and the last few years have seen significant investments in bold, ambitious projects to create consumer credit products that scale.

For many traditional lending institutions, digitalisation projects of this size require building complex technical solutions that, for them to work as promised, may in turn require deep, sophisticated technical knowhow, infrastructure investments, training and upskilling of teams, and a transformation of business practice and culture. To achieve what?

Many banks and MFIs are consciously seeking to avoid replicating the Fintech consumer credit model, which has often resulted in excessive liquidity to consumers, poor collection practices and high interest rates. They’re racing to keep up with Fintechs, while at the same time trying to figure out how to build a new model of more inclusive finance, one that’s not just ambitious about banking the unbanked, but ambitious about doing it in a healthy and sustainable way. But to reach this end, it may help banks and MFIs to stop worrying about their digital transformation, and start looking at their customers’.

The digitalisation of today’s entrepreneurs

Though the numbers vary from country to country, it’s been estimated that in Africa over 85% of people work informally. These are workers in industry, agriculture and services – which includes a growing number of digital platforms – for whom credit has long remained out of reach. MFIs and banks aspire to include them, but if today’s new digital products are built on top of yesterday’s approach to credit, we may not be opening up the opportunities we hope for. Take these three cases of entrepreneurs at various points on their own digitalisation journey:

• The fisherwoman

Adwoma sells and processes fish caught by her husband and their family of fishermen. Things have never been easy along the shores of the Gulf of Ghana. Overfishing continues to deliver diminishing returns for the fisherfolk of her region, but the men depend on her sales to pay for the petrol, food and supplies for their fishing expeditions. Covid-19 restrictions were devastating on fisherfolk as markets were closed, and they were cut off from fishmongers, and dealers took advantage to buy her catch at a loss. But soon Adwoma found another solution by joining a small platform that connects fisherfolk directly with final consumers who order and pay by phone. Credit would allow Adwoma to finance fishing trips or even pay for refrigeration to reduce losses from spoilage.

• The food stall owner

After borrowing money from family to get started, for the last ten years business was modest but steady at Jean’s food stall in Senegal. But since signing up to one food delivery service platform last year, and then another this year, his orders have more than doubled. Now, it’s a balancing act to manage in-person customers with platform orders, especially as online customers can so easily leave negative feedback for delays or mistakes. He’s got a series of family members who help out occasionally, cooking or shopping for supplies, but what Jean really needs is additional equipment – an extra fryer, for example – to help him serve all his customers at peak times.

• The ecommerce seller

Jasmine is a 25 year old seller with a small but growing online shop offering a curated selection of Made in Cameroon clothing, jewellery and food items. She was surprised by her success when she first started casually reselling items she found to her extensive network of Facebook friends using mobile money. Then she took the leap and set up her shop on a well known digital platform. She has a diploma from a vocational school, but it’s her fluency with social media that continues to help her grow her business. While her lack of business knowledge makes her sometimes doubt herself, Jasmine has ambitions to sell more cross-border, not just around Africa but in Europe and America as well. With access to credit she could source and stock more inventory, get professional photography for her products and invest in sponsored Instagram campaigns to help her business stand out from the competition.

While not comprehensive in describing all the ways entrepreneurs are digitalised and can benefit from credit, each is a clear example of the kind of people that traditional financial institutions with traditional credit models don’t reach.

But lenders with access to different models may be able to build a strong case for why each of these informal entrepreneurs are creditworthy.?

Platform data and creditworthiness

The common thread here is platform data, from Adwoma’s first forays into selling her fish direct-to-consumer, to Jasmine’s more extensive experience sourcing, stocking and selling products to a range of customers even outside her region. This platform data can provide a wealth of information on each entrepreneur’s business practices – and thus indicate the strength of their ability to repay their credit.

Defining the loan purpose

Platforms also provide a strong, salient context for credit. Digital entrepreneurs will most likely take a loan to expand their business based on clear objectives that can be linked to their business activity. While they’re borrowing for “off platform” activity – say, Jean borrowing to buy a fryer, or Jasmine borrowing to invest in Instagram advertising – their purpose for borrowing can be defined and to some extent measured in terms of business impact.

Enabling automatic payment

Another advantage of platform data is that it empowers embedded lending solutions that are already being implemented by some innovative platforms: automatic repayment. Automatic repayment enables loan repayment to be deducted from future earnings, giving a very strong boost to repayment likelihood. While there has been some criticism that this practice, in a sense, masks the borrower’s “true ability” to repay, this mechanism is one more lever – like automatic payment of bills – working to help them establish and grow a solid credit history which will then enable them to gradually move towards larger loans in the formal finance system.

Sales networks, not social networks

While alternative credit scoring has been dazzling with the promise of mining phone usage and social media data like Jasmine’s, it’s her platform data, more than her than alternative credit scoring proxies (and more than classic socio-demographic credit application data), that may give us the clearest idea of her creditworthiness. With data representing real financial flows, lenders can make much safer bets on Jasmine or Jean’s ability to do business, and thus repay their loan.

The challenge of scale

There are still challenges in devising products for people in these different situations. They each represent varying degrees of digital literacy, from the tech-savvier Jasmine on down. Limited internet penetration along the Gulf of Ghana coast and the limited digital literacy of Adwoma and her fellow fisherwomen must necessarily result in different financial products, built to different technical specifications and communicated differently. Jasmine, instead, has a full-feature phone with a robust data plan and few to no service cuts. She may want a more sophisticated product with more personalisation options delivered by an app with high-quality UX to match the social media platforms she knows so well.

Creating different experiences and different products for different people means there’s a limit to how much these solutions can scale – but with the right data and embedded lending services, that scale might be well beyond what we can imagine now.

But with digitalisation continuing apace, and more and more people buying, selling and performing services via platforms, there’s a new opportunity to lay the groundwork for healthier, more sustainable and more inclusive finance.