Disruptive Forces Needed In Banking

Mark Zuckerberg came, saw and conquered. Kenyan social, print and television media was alight with highlights of his visit and for good reason. Our hotbed of innovation is presumably a key driver for choosing the country in his Africa tour. And given the rate at which banks are submitting themselves to the interest rate capping law, financial innovation should now be a logical outcome of the compressed margins and resultant lower profitability within the banking industry.

But let’s park that aside as this was all about Mark and his globally transforming social media platform that has now become a rapidly growing business tool. I first heard about the disruptive use of Facebook as a credit scoring mechanism at a G20 financial innovation conference in Turkey last year. A panelist from the American online lender Kabbage Inc. informed participants about how their credit lending algorithm went beyond the traditional, historical and fairly outdated banking industry credit assessment mechanisms. They used a borrower’s online persona to determine ability to repay using a variety of parameters and one of those parameters was the borrower’s activity on Facebook.

In a Forbes Magazine article titled “The Six Minute Loan: How Kabbage is upending small business lending” the genesis of the growth of Kabbage is well articulated. “The seeds of Kabbage, founded in 2008 and based in Atlanta, were sown by Rob Frohwein, an intellectual property lawyer. Now CEO, Frowhein saw how much data was becoming accessible via the cloud and that companies like eBay and PayPal were providing application programming interfaces that a lender could use to get real-time access to a business’ customer transaction data. Kabbage, Frohwein says, put the two concepts together. One reason Kabbage has been able to attract capital is its loan default rate. Even though it can assess applicants in minutes and never demands a personal guarantee, Kabbage says its loans are as likely to be repaid as those of traditional banks, which routinely take weeks to make a decision.”

Now this is a very interesting concept. While interest rates are coming down rapidly within the banking sector, loan approvals for unsecured personal and SME loans will not necessarily increase in tandem as the risk profiles of customers is not in any way changing. Yet these borrowers need a source of financing and Kenyans are about to wake up to the often beaten, but much ignored, drum that pounds the message: borrowers are as indifferent to rates as they are as desperate to get a loan approval. Back to the Kabbage story from Forbes, “Frowhein says Kabbage targets established businesses rather than startups, with its automated model assessing three factors: capacity to repay, character and the consistency or stability of the business. ‘We believe we get to know a small business better by being connected to their data sources electronically than any loan officer can do by sitting down at a desk with the borrower,’ says Frohwein. He says Kabbage incorporates nontraditional metrics such as a company’s Twitter or Facebook followers, as well as the online reviews of its customer’s posts as a way to round out an applicant’s story. ‘You won’t get a loan because you have 7,000 likes on your Facebook page,’ he says. ‘But we might increase the cash available to you if you have an active social media following because it establishes the credibility of your business with its customers.”

Now for all the banter I saw on social media about the number of countries that have interest caps, with some pundits including the United States in that category, this will come as a surprise. The average annual percentage rates (APR) of Kabbage’s loans to its American small business customers are 40%! The same article quotes Frowhein as saying “the rates range form 1.5% to about 20% for the first two months of the loan, depending on a variety of risk factors and how long the cash is kept, and then drop to 1% for each subsequent month.”

Yes. I see you. I see the wide saucers that your eyes have become. Let me provide you with the definition of APR: An annual percentage rate is the annual rate charged for borrowing and is expressed as a percentage that represents the actual yearly cost of funds over the term of the loan. This includes any fees or additional costs associated with the transaction. So your Kabbage borrower is someone who has been unable to get a loan approval from a bank for whatever reason (more often than not a poor credit rating score, or worse, no credit rating score as the borrower has not built enough of a credit history) and will take what’s given since it is approved in six minutes, rather than weeks and does not require collateral such as a log book or title deed. In case you’re wondering whether Kabbage is a two-bit flash-in-the-pan player, it’s not. Since it launched in 2009 the company has lent more than $750 million (Kshs 75 billion) to small businesses and expected to lend $1 billion (Kshs 100 billion) in 2015 with revenue exceeding $100million (Kshs 10 billion).

The winner of this interest rate capping law is not the individual or SME borrower. Their risk profiles are such that they will be unattractive to lend unless a secure mechanism for quickly collateralizing and liquidating fixed and movable assets is put in place in Kenya. Such a system has to be backstopped by an efficient and incorruptible judiciary that will allow realization of securities to occur thereby reducing the drag currently endured by banks in liquidating bad debt. The true winner will be the fintechs that can very quickly dis-intermediate the banking system by providing credit to individuals and SMEs a) without collateral and b) within minutes. Timing is key in business, as it enables quicker turnover leading to conversion of goods into cash that is used to pay off the high-interest loan and put debt free funds into the pocket of the borrower.

Twitter: @carolmusyoka