NB Financial Health
Microlending Peer to Peer … and Back Again: After six years, Zidisha CEO presses for low-debt loans, high transparency
In recent months, the microlending industry has faced a steady drumbeat of criticism for both its practices and its impact on poverty. Many have called for more transparency and increased accountability – and raised concerns about the often high cost of microloans to poor recipients. Since it was founded six years ago, the nonprofit Zidisha has sought to accomplish these tasks by providing a direct connection between lenders and entrepreneurs in developing countries. By avoiding the middlemen (ie: microfinance institutions) that some other online person-to-person platforms depend on, Zidisha has removed interest from the borrowing equation, lowering the cost for loan recipients. In the process, it’s providing more than 25,000 entrepreneurs with a platform for funding their businesses, and sharing their entrepreneurial and even personal aspirations.
I caught up with Zidisha Founder and CEO Julia Kurnia to find out how the platform does things differently than its online peers and what effect direct lending is having on the broader microcredit sector. Below is part one of our interview. (Check out part 2 here.)
James Militzer: I understand that borrowers may take out Zidisha loans for any (legal and ethical) purpose, even if it’s not related to entrepreneurship. Do you know what percentage of loans are used to start or grow a business, and what percentages go to other purposes (education, health care expenses, etc.)? Are there any concerns about repayment and over-indebtedness, when loans aren’t being put to use for income-generating activities?
Julia Kurnia: In the past month, over 90 percent of loans were used to start or grow businesses, 9 percent were used for university tuition or other educational investments, and less than 1 percent were used for consumption expenses such as health care or home improvement.
When loans are not being used for revenue-generating activities, we ask applicants to explain to lenders the source of income they’ll use to repay the loan. For example, university students frequently have part-time jobs that can ensure repayment of tuition loans while they are studying.
In traditional microfinance programs, loan officers often visit applicants in person to evaluate cash flow and repayment capacity before issuing a loan. Zidisha does not have loan officers or any staff in borrower countries. We instead strive to prevent over-indebtedness by requiring everyone to start with a relatively small loan, and increasing credit limit gradually as the small early loans are successfully repaid.
JM: Does Zidisha measure the social impact of its loans, in terms of what percentage of loans result in successful businesses, household income increases, etc.? If so, what have you found? If not, how do you gauge your impact?
JK: As a self-funded nonprofit, we haven’t had the resources to commission a large-scale field study of household incomes among loan recipients. It’s something we’d like to do in the future, when funding allows.
That said, we see evidence of impact in solid repayment performance, and in the strong demand from new loan applicants. Even though we do not do any marketing to borrowers, word of mouth growth often results in more applications than we have the capital to finance.
For us, some of the most compelling evidence of impact is the progress updates the entrepreneurs post themselves. We frequently hear that business earnings enabled by Zidisha-funded investments have made it possible for entrepreneurs’ children to attend better schools or access higher education, or that the growth in business capacity has resulted in job creation.
JM: I understand that Zidisha formerly allowed borrowers and lenders to set their own interest rates and then decided to cap those rates last year. But now the cost of loans for borrowers on the site only mentions a service fee, and Zidisha’s FAQ says that no interest is charged. Can you explain Zidisha’s evolution on this issue – why you allowed interest initially, and why you stopped?
JK: Especially in our early days (we were founded in 2009) Zidisha was an experimental platform. Nobody had tried direct peer-to-peer lending across international borders before, and there was no road map of established practices to follow. For this reason, we have adjusted our lending model many times in response to lessons learned.
Initially, we expected that higher interest rates would attract more lending capital to the platform, helping us extend loans to more entrepreneurs. Our intent was to allow market mechanisms to set an optimal interest rate, which would result in a maximum of loans funded at a cost that was beneficial to both lenders and borrowers.
What we didn’t anticipate was that more lenders disliked the higher interest rates than were attracted by them. Even though lenders could opt to receive less than the maximum, many thought it unfair that other lenders were receiving higher rates, driving up the cost to the borrower. After all, Zidisha is a philanthropic platform, and the main reason most lenders came to it was the low cost to the borrower. In addition, our data over time showed that higher interest rates tended to reduce loan repayment rates.
For these reasons, we stopped offering interest on new loans in February this year. In lieu of paying interest, each borrower makes a one-time, withdrawable (sic) deposit into a reserve fund, which is used to refund lenders in the event of default. The only cost per loan is a flat 5 percent service fee, which covers money transfer charges.
JM: What is Zidisha’s current average default rate? Has that changed over time?
JK: We estimate the default rate for loans currently being issued at 10- 15 percent (before lenders are refunded by the reserve fund). It was substantially higher in 2009 – 2013, when we were still learning and improving our lending model in response to experience.
We publish detailed repayment statistics by time period and country here.
JM: Without a staff of paid workers on the ground in the countries in which you operate, how are you able to assess borrowers’ qualification for loans, deal with non-paying borrowers, and manage other elements of your operations?
JK: We are similar to other decentralized online marketplaces like eBay and Airbnb, in that we strive to build a community that attracts responsible members and uses shared norms and positive incentives to promote good behavior.
Probably the main reason for solid repayment performance is that Zidisha loans are dramatically more affordable than the other sources of finance available to most of our members. Most entrepreneurs are careful to repay Zidisha loans on time to ensure they maintain access to raise zero-interest loans through our platform in the future.
Another important reason that repayment rates at Zidisha are high is that we allow members to adjust their weekly repayment commitments up or down in response to financial setbacks.
JM: I understand that Zidisha allows borrowers to reschedule their payments if they’re unable to meet their original obligations. How does this work, how often do borrowers reschedule repayment, and has it caused any tension with lenders who were expecting repayment on the original schedule? Is this something you try to discourage among borrowers?
JK: Most Zidisha loans are repaid in weekly installments. The installments may not be delayed or skipped, but their amounts may be adjusted up or down at the borrower’s initiative in response to changes in cash flow.
In our experience, rigid repayment schedules typical of traditional banks do not fit well with the reality of cash flow in informal businesses, where the entrepreneurs lack health or asset loss insurance, substantial savings or other safety nets that people in wealthy countries take for granted.
We consider it an important ethical obligation that our loans do not cause harm by forcing people to choose between fulfilling their family’s basic livelihood needs and staying current with repayment schedules. At the same time, we have a responsibility to our lenders and the community to take effective measures to prevent irresponsibility and free riding. Our repayment policy is a result of what we’ve learned over the past several years in balancing those two obligations.
At the time of application, each entrepreneur chooses the amount they would like to commit to repay each week, and the day of the week they’d like their repayment to fall due. If financial circumstances change during the course of the loan – for example, an unexpected hospital bill needs to be paid, or a business downturn coincides with children’s school fees falling due – the entrepreneur may reduce the amount they commit to repay each week. The weekly repayment may be any amount at all, but it cannot be zero. As long as the entrepreneur continues to meet the new weekly repayment commitment without skipping or delaying, they maintain their good on-time repayment record with Zidisha. Typically, weekly repayment commitments are adjusted upward again once the financial setback passes.
We do our best to prevent tensions with lenders by being as transparent as possible about borrowers’ ability to adjust weekly repayment amounts, educating them about circumstances in developing countries and explaining why we believe this flexibility is optimal for lenders and borrowers alike.
James Militzer is the editor of NextBillion Financial Innovation.