Lenders get creative to finance small businesses in developing markets

Welcome back. Financial innovation got a bad name for itself after the 2008 financial crisis, when arcane structures built around US subprime mortgages threatened to bring the global economy to its knees. Even today, to many ears the phrase evokes Wall Street shenanigans that increase the incomes of a select few.

But there is huge scope for innovative approaches to tackle problems of financial exclusion, especially in developing countries, and lift the incomes of families and small businesses who remain underserved by the formal financial sector. Today we highlight a few interesting companies, in three very different parts of the world, aiming to do just that.

financing developing markets

Inside the fresh ways lenders are bringing finance to farming communities and beyond

When Hugo Garduño Ortega started exploring opportunities to get involved in Mexico’s booming financial technology start-up sector, he noticed a striking pattern.

As in other developing economies, a huge share of Mexican households and small businesses struggle — or are simply unable — to gain access to financial services that could help them prosper.

But even as Mexican fintech start-ups attracted growing interest and cash from international investors, they were focused on serving the already affluent rather than tackling financial exclusion, Ortega found. “Everyone’s speaking about consumer lending for the same people that already have credit cards,” he said. “It’s incredible — no one’s actually trying to serve rural communities.”

Ortega’s business, Verqor, is intended to buck that trend. It’s one of a growing number of start-ups in developing nations using technology, data and innovative lending practices to extend finance to small farmers and other underserved groups.

The lack of credit history for many Mexican farmers is a deterrent for many banks. So too are concerns about the availability of collateral for loans, especially given that agricultural land is often owned by a local community rather than a single farmer.

Verqor aims to dodge these problems by taking an approach that’s totally different from conventional bank lending. It asks potential clients to give it access to their trading data from the past five years, which it analyses to build a detailed picture of their business. This means that even if they have no formal credit history — which is the case for 60 per cent of customers — Verqor can assess their likely ability to repay the loan.

The loan is provided not in cash but in a credit balance that can be used to buy agricultural inputs such as fertiliser through Verqor’s own platform, with the goods collected from local distributors. “If you give credit, you may want to make sure that it’s productive,” Ortega said. “You don’t want a farmer just to get a new pick-up truck with the credit you gave for fertilisers.”

Verqor further reduces default risk through its approach to repayment. When the farmer delivers the product to the customer, payment is made through Verqor, which takes the amount owed on the loan before transferring the remainder to the farmer.

While this approach may appear restrictive, it enables Verqor to provide credit to farmers at far lower interest rates than charged by the informal money lenders on whom they would otherwise rely, while minimising the risk of default. Ortega says Verqor’s non-performing loan rate has been 1.7 per cent over the past three years, and 0.4 per cent over the past 12 months. That compares with the overall rate of 1.9 per cent for Mexican banks as of June, according to CEIC Data.

Verqor is one of more than 70 businesses in over 30 countries that have received investment from Accion Venture Lab, an impact-focused investment vehicle run by US-based non-profit group Accion International.

“We see financial services as a means to an end,” said Rahil Rangwala, one of two managing partners at Accion Venture Lab. “You can provide access to a loan — but does that mean that the farmer is going to be earning more? Does it mean that the small business can stock more of what they sell and manage their cash flow better?”

Nairobi-based Apollo Agriculture has applied a similar logic to provide credit to about 380,000 small farmers in Kenya and Zambia. Its customers sign up through field agents who inspect their farms and perform basic due diligence. Apollo offers a package of “everything you need to succeed”, says chief executive Benjamin Njenga, including fertiliser, seeds and crop insurance. Like Verqor, Apollo provides clients with vouchers that can be exchanged for goods at local shops. The loan is repaid after the harvest through mobile money — ubiquitous in Kenya and increasingly widely used elsewhere in Africa.

“Their mission is: ‘We want farmers to make more money,’” says Amee Parbhoo, the other managing partner at Accion Venture Lab, which has also invested in Apollo. “It’s not even about the financial product. It’s about knowing what to provide to enable them to have a more productive yield, which means more money for them.”

In Indonesia, former HSBC banker Fajar Adiwidodo is applying a similar approach to support small-scale manufacturing businesses, which commonly struggle to access credit for working capital. “So they have to buy their raw materials in cash, and when they deliver their products to the buyers they always get paid in arrears,” Adiwidodo said. “It’s a funny thing about this world that the smaller companies have to finance the bigger companies.”

Adiwidodo’s company, Bababos, provides small manufacturers with raw materials such as steel bars or raw polymers. When its clients sell their finished products, it collects payment directly from their buyers through an escrow account system.

Since starting business two years ago, Bababos has attracted more than 400 small manufacturers as clients, and is now generating monthly revenue of about $1.2mn. Its non-performing loan rate is currently about 0.3 per cent, far lower than the typical rate for Indonesian bank loans to small businesses, Adiwidodo said.

Bababos’s practice of providing its clients with goods, rather than cash, has been a key factor behind this low default rate, he added. “Banks need collateral because they’re not comfortable” with the clients’ risk profile, he said. “But by controlling the supply chain, we can solve that.”

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