Blockchain for microlending

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Microlending can be boosted with the use of blockchain. Micro, Small and Medium Enterprises (MSMEs) and individuals are in need of credit, but do not always meet banking standards and criteria. As a result they are excluded and this makes it challenging to avail of credit at reasonable interest rates and through legitimate lenders.  

Here are a few reasons for the funding gap to MSMEs and individuals

  1. The cost to extend and monitor credit does not make economic sense for many financial institutions and cooperatives.
  2. The existing borrowers are already in debt and are stuck in a vicious cycle with ridiculously high interest rates imposed by middlemen.
  3. Individual identity and credit history is not available based on the traditional standards.

How big is this funding gap? What is the addressable market?

In an IFC and McKinsey joint report published in 2010 (yes, it’s a bit dated), this number was estimated to be between $2.1 trillion to $2.5 trillion across 365 million to 445 million formal and informal MSMEs. This excludes high-income countries is just for the MSMEs, not including individuals.

          Source: IFC and McKinsey report, 2010.

 

Source: IFC report Closing the Credit Gap for Formal and Informal Micro, Small, and Medium Enterprises

What can blockchain do?

  1. Reduce the cost of monitoring through smart contracts and keep the documentation trail which provides transparency and security.  
  2. Reduce the middleman and connect the lender to the borrower directly.
  3. Allow for new ways of identity checks and also for maintaining credit history.

Focusing on individuals, one has to also realise that poor people typically and broadly speaking do not want to default, are looking to better their lives, and have the intent to pay back loans. The CGAP has quite pointedly highlighted why those who access microcredit look to pay back their loans:

  1. They value formal microfinance highly because it is more reliable, even if it is often less flexible than their other tools to manage their cash flow.  
  2. Most important, they usually repay those loans at extremely high rates year after year, when the main motive to repay is not collateral or group pressure, but rather their desire to keep future access to a service they find very helpful.

Repayment is one thing, but many a time the loans are taken to meet personal needs and not business needs. Blockchain technology can track the uses of these loans and what they are also being utilised for. It can also support business ideas that are not usually funded as now one can track through smart contracts. It could open up a P2P lending aspect besides cooperatives and small group lending. This would would take out middlemen, but at the same time open up the source of available credit beyond traditional methods.

Again, although the intent is there, the general perception of how blockchain technology is complex could keep people away from adopting it.

That being said a lot of the projects are still in the ideation or initial implementation stages, so it might be too soon to toot the horn of how blockchain technology can address this market at affordable levels and make it more scalable in its approach.

 

Sources:

  • http://documents.worldbank.org/curated/en/386141468331458415/pdf/713150WP0Box370rillion0and0counting.pdf
  • http://www.cgap.org/blog/does-microcredit-really-help-poor-people
  • https://www.ifc.org/wps/wcm/connect/4d6e6400416896c09494b79e78015671/Closing+the+Credit+Gap+Report-FinalLatest.pdf?MOD=AJPERES

Featured image credit: HiH – Enterprise – 40 – Cotton Weaving – Dimmarajan Petta – 08