In South Africa, lower-income consumers and thousands of vendors were for years barred from accessing the formal credit sector due to a lack of security deposits or other collateral. The ripple effect of this is still evident today and the financial sector still needs to make huge strides before it can fully claim financial inclusion status.
Access to credit empowers consumers to afford purchases they may not be able to outright buy with one month’s salary. For small businesses getting credit not only advances the individual business owner but also helps a country’s entire economy grow.
There are, however, institutions, credit bureaus, and third-party platforms that are making it their business to disrupt the status quo by leading the way with alternative credit scoring and new lending models. These new credit models give previously financially crippled consumers access to money by using alternative data to check their creditworthiness.
Traditional credit barriers & the value of alternative data
Financial institutions that rely on traditional data and credit scoring have one thing in mind – does the consumer have enough money or collateral to pay us back?
To determine a consumer’s creditworthiness, these institutions will look at the earning power, unbonded assets, length of residence and credit history. It’s nothing new to say this is a flawed model, with individuals and sectors being entirely excluded because of their socioeconomic standing. Traditional credit scoring creates a vicious cycle, where a consumer isn’t able to build a healthy credit history due to the only available credit being extremely risky and expensive.
There are thousands of cash-based vendors and growing SMEs in South Africa where cash flow data doesn’t really exist. These business owners struggle to get access to credit. Traditional credit risk assessments for businesses are usually in the form of due diligence on the directors, where an individual’s credit history is assessed. According to the Oxford Business Group, until quite recently the banking sector in SA has been controlled by 4 major banks that are known for being risk-averse. These banks hold the purse strings and own more than 80% of the banking sector’s total assets. When it comes to traditional lending, a lot of SMEs and consumers get the cut as they don’t meet the lending criteria. The perpetuating cycle means that nearly a third of South African consumers have unmet credit needs.
So what needs to change and what can South Africa do? Consumers and financial bureaus need to find ways to leverage alternative data to determine creditworthiness. Alternative credit scoring makes use of data from digital platforms and applications where consumer behaviour is tracked.
The data is able to provide potential borrowers, especially those with no credit history, a loan opportunity by calculating their score and risk potential based on various behaviours. These behaviours can include telco data (call durations, duration of SIM ownership, cellphone contracts paid on time), e-commerce history, utilities and bill payments and social media behaviour.
When we adapt credit scoring models, lenders can expand credit to an entirely new target audience. Not only helping the underbanked gain access to credit, but also helping millions of consumers to establish their credit history (which can be used for future credit assessments).
“Digitized finance coupled with alternative credit scoring makes it easier and less costly for consumers to get the money they need.” Christopher Ball, co-founder of Finch Technologies, Fintech startup.
Large corporates like Shoprite and Vodacom are making it their business to offer affordable small personal loans within their apps. Credit shouldn’t be a disabler and consumers shouldn’t automatically be put into a bad debt cycle. Instead, these small loan amounts can be easily paid off with different payment terms. Vodacom’s financial product Vodalend makes use of alternative data such as “customer’s recharge and payment behaviour” to determine their credit worthiness.
The credit evolution
Alternative credit scoring is an industry game changer, and although it isn’t a new kid on the block, this risk assessment model will need to adapt as technology and consumer behaviour evolve. As alternative lenders continue to emerge, traditional banks’ will have far less of a hold on the lending market. New technology-driven credit assessments mean that financial inclusion in South Africa is one step closer for both consumers and SMEs.
How can these lenders use alternative data successfully? The reality is that there are still constraints for large corporate lenders when it comes to regulations and processes which often means it’s much slower to get an alternative lending solution to the market. Alternative data solutions such as CreditVision from TransUnion allow lenders to assess consumers more accurately using a variety of demographic information. This way ‘thin-filed’ consumers have a better chance of gaining access to credit that aligns with their level of risk. According to Transunion, at any given time there are “ three million South African consumers who could not be scored using traditional credit data but were well-performing consumers when they did become credit active”, meaning alternative data gives a well-rounded risk assessment of individuals’ ability to repay a loan.
According to TransUnion Q2 2022 report, consumers want to get themselves out of bad debt cycles and with the unemployment rate decreasing in Q2 of 2022, 35% of consumers stated that they had paid down their debt faster over the past three months. This is partially due to alternative lending products being designed to financially assist consumers rather than further hinder them.
As alternative data becomes more prevalent, it’s becoming increasingly important for the SME lending ecosystem. Alternative data makes the lending experience better for borrowers and lenders alike, and these lenders are able to minimise costs. An integrated assessment of an SME’s invoicing data will give a holistic look at their overall business health and potential performance. Alternative data such as digital wallets, e-commerce analytics, social media analytics, book-keeping tools, websites, mobile applications and geolocation data can all be used when assessing the risk of a business.
“Experian believes that the traditional credit risk score that lenders have used for decades needs to evolve, because consumer credit and money management, particularly during hard economic times, has changed. A much more complete picture of the consumer at a hyper-personalized individual level is revealed when we include additional sources of data, such as alternative information, consumer-permissioned data, rental and utility payments, public records, spending, travel, and association habits. Alternative credit scores offer extra information to enhance decisions throughout the whole credit life cycle and reduce risk. Leveraging non-traditional data and Machine Learning, non-traditional data-based credit risk scores, such as Experian’s Sigma Transcend score, are able to give the ‘credit invisible’ or thin-file consumers a chance to access regulated formal credit. Ultimately, this vast volume of information combined with advanced analytics results in increased consumer access to credit and lucrative business for lenders through better business decisions.” Jaco van Jaarsveldt, Head of Strategy & Innovation, Experian Africa
Trends leading the charge
According to McKinsey’s Tech Trends Outlook for 2022, AI will continue to have a significant impact on the financial services industry where it is able to support risk management by detecting credit card fraud and reducing losses.
Web3 will be another game changer in the financial sector, where Decentralized Finance (DeFi) will be able to autonomously perform services similar to traditional financial institutions. However, the biggest difference is that the revenue will be given over to the users or liquidity providers of these applications. Cloud computing will also be of increasing significance for financial players, where cloud services can be used to efficiently train and deploy algorithms that model risk and improve fraud detection.
Digital trust technologies or Know Your Customer (KYC) solutions, like Gathr were created with the intention of mitigating risk and fraud. Customer onboarding through a KYC journey enables organisations to implement and provide their products and services to consumers digitally. According to Forbes, it is forecasted that by 2022, 75% of organisations will be using a single vendor with strong identity orchestration capabilities for identity proofing and affirmation. Forward-thinking South African banks like Capitec, have already implemented modern KYC solutions into their mobile apps, where customers just need to take a selfie for ID verification instead of uploading a document.
In the lending industry, there are several trends leading the charge, BNPL (Buy-Now-Pay-Later) being at the forefront replacing the traditional layaway payment model used by stores like House & Home. One key differentiator with BNPL is that consumers are able to secure their purchases immediately rather than having to wait until all instalment payments have been made. There are still plenty of questions surrounding BNPL, the potential impact on inflation, the broader impact on the e-commerce industry and how credit agencies are monitoring this payment/lending model.
Transparency in the lending industry has put the power back into the borrower’s hands, where consumers can compare offers from multiple lenders all on one marketplace platform. Platforms like Fincheck, Hippo and FundingHub give consumers a step up by letting them choose the best finance option suited to their needs.
In South Africa, the credit landscape is constantly changing, with financial institutions continually looking for new and better ways to give their customer’s finance. Alternative data will continue to transform the way lending is done, and technological advances will make it even more accessible for South African consumers.