For customers, size – and speed – matters
There’s a problem with the standard approach to microfinancing. While it’s undeniable that standard MSME microfinance loans can help informal entrepreneurs make important investments into a new or existing business, the terms and loan amounts may be less sustainable long term. Our own research conducted in Sub-Saharan Africa showed us that in many cases the loan sizes and terms created larger and longer-term debt with more rigid repayment schemes than borrowers wanted – but unfortunately they had few other options.
At least, few other formal options. The reality is that despite obtaining a substantial formal microfinance loan, many MSME entrepreneurs still engage in multiple borrowing from informal sources like family and friends. The reason is that they still need fast, flexible, short-term infusions to cover wages until a client pays, or seize a time-sensitive opportunity, for example to buy a load of merchandise just arrived cross-border. The unfortunate irony, of course, is that this informal borrowing is the very practice microfinancing is meant to replace.
What’s stopping MFIs from offering nano loans?
If smaller, faster loans would be a better fit for MSME microfinance customers, why don’t more MFIs (microfinance institutions) offer them? There are a couple of major obstacles, the most important of which is profitability. Every loan must cover the fixed costs of the application process, including evaluation and disbursement. And for traditional MFIs that rely on long and efficient loan renewal processes, these costs remain fixed even when clients are on their second, third or tenth cycle. To put it simply, in their current form, nano loans don’t pay for themselves.
Another issue is that flexibility is challenging to design. Flexible repayment might be desirable for the individual borrower, but for the traditional MFI it means more variables and unknowns. When loan officers play an essential role in the MFI customer experience, flexible repayment can make loan follow-up harder to manage.
A nano loan solution that starts with behavioural data
At Rubyx, we’re strong believers in leveraging behavioural data as the best indicator of creditworthiness, whether it’s transactional data from platform workers or loan repayment data that enables automatic renewals. Which is why we’re working with this data to make nano loans profitable for our MFI clients and fast and flexible for their customers.
Here are the ingredients of a successful nano loan solution for MFIs:
MFIs can start by offering nano loans to their current customers with sufficiently good repayment behaviour. These customers are pre-approved through automated loan approval processes, and will most likely repeat their same good repayment behaviour, meaning the institution can save on costs associated with finding new customers, analysis and loan management.
Tailored offers, instant disbursement
The MFI solicits their pre-approved customers with the loan offer – without waiting for the customer to come to them. Each nano loan is tailored to a customer’s repayment capacity, which means there’s potentially a loan for everybody. The loan offer doesn’t have an expiration date, but is available if and when the customer needs it, giving the customer peace of mind. And when they accept the loan offer, the loan is disbursed instantly with the help of lending automation.
Ultimately, informal borrowing persists because family and friends know the borrower will repay as soon as they can, and not necessarily according to a rigid schedule. Institutions can mimic this flexibility with a fixed price loan that offers automated incentives for early repayment (e.g. amount increase for next cycle) and disincentives for less desirable behaviour (e.g. amount decrease for next cycle, freeze periods or disqualification from future access).
Would a nano loan product like this work for MFIs? In our experience, definitely! Interestingly, while our own research found that many of our clients’ customers were initially reluctant to buy into the idea of nano loans, many more responded positively once offered the loan – perhaps because, as many said, what they really wanted from their MFI were small loans available quickly in the moment of need. Nano loans meet this criteria.
Repayment data we’ve gathered so far from clients show that customers repay in ways we can predict from our initial credit scoring – the best customers repay the most quickly, good customers repay a little less fast. But because these are small, short-term loans, customers can have more fresh starts, more opportunities to demonstrate better repayment behaviour over additional cycles.
Automation is key
One last thing to emphasise about the essential nano loan ingredients above – really, the glue that holds it all together – is automation. It’s only by automating the marketing, decision, disbursement and collection strategies, that the microfinance institution can sufficiently save on transaction costs in order and make nano loans small enough to serve a wide range of business customers profitably. In fact, one client we worked with saw a 12% uplift in revenues from better digital loan offers.
Innovative microfinance institutions looking to be truly transformative in 2023 might want to consider just how huge nano loans can be.