Would you lend a stranger your savings so they could buy their dream home? How about if they needed money to invest in their Fintech startup?
Well, you have probably never faced these scenarios. However, it would be the norm if banks did not exist.
Banks play an essential role in society by ensuring savings (money that is not being put to active use), can be used elsewhere in the economy. When banks work well, savers who want their savings to grow over time through interest do not need to worry about trusting strangers; they only need to trust their bank. At the same time, individuals/businesses with borrowing requirements can turn to banks instead of needing strangers to trust them.
Depositing your savings with a bank is safer than lending to strangers directly, not because trustworthy people run banks, but because banks do not rely on trust when they lend your savings. They rely on something more tangible. They rely on data.
In data we trust
Data is what enables banks to make rational lending decisions when we apply for credit. By analysing data on our spending and borrowing behavior, banks can get a feel for how reliable we are with money, and estimate the likelihood of defaulting on a loan.
The data needed to work this out is acquired via sources ranging from your network provider to other banks. And to ensure this data is consistent, governments task Credit Bureaus (CB) with verifying and centralising this data. Warehousing all that data puts CBs in the best position to analyse it on behalf of banks; which they then simplify down to a single numerical proxy for creditworthiness called a credit score.
Credit scores often form the basis of a bank's lending decision making them a key component of an economy's credit infrastructure. Their importance is the reason many countries ensure CBs capture data for all adults.
However, while CBs in countries like South Africa and Namibia only cover 68% and 61% of adults respectively, Nigeria scores very low on this metric at 11%. Even then, this figure is based on Lagos alone, meaning Nigeria's actual coverage is probably lower.
Such a low coverage means banks can only determine the creditworthiness of a few Nigerians and helps explain why only 1.3% of Nigerians were able to turn to banks for loans in 2018. To make credit available for every creditworthy Nigerian, CBs need data on more Nigerians.
Scoring more data
There are several reasons why Nigeria has a low CB coverage; for starters, Nigeria has a poor data collection culture. For data to be useful, it needs to be accurate, consistent and timely. Often data that is collected in Nigeria fails to meet all three of these criteria making a lot of data unreliable.
Traditional credit scoring suffers from the chicken or the egg dilemma. The majority of data that forms your credit score is your credit history. However, there are only a few Nigerians who have a formal credit history. If that isn't limiting enough, only loans over ₦1 million are required to be reported to the CB meaning data captured by microlenders is not always reported.
The lack of formal credit data in Nigeria not only impacts the number of Nigerians we can determine creditworthiness for, but it also means there is less data for bureaus to learn from and improve the accuracy of their credit scoring. With no immediate fix for the lack of traditional creditworthiness data, maybe Nigeria needs to rethink credit scoring.
Rethinking credit scoring
While the lack of coverage by the CBs limits the ability of banks to lend to the average Nigerian, alternative lenders have been able to fill in this gap by embracing different methods of credit scoring.
Take Social Lender, for example, a company which provides loans of up to ₦100,000 using your social reputation score. A score that even includes data from your Facebook activity. By using the vast amount of data produced by our social and digital activity, lenders are now able to analyse lots of data about us to get a better picture of our creditworthiness.
While the success of alternative lenders is positive, they're not big enough to have a transformational impact on the access to credit in the economy. We still need the banks.
With around 80% of Nigerians using mobile phones and over 50% using the internet, the digital footprint of the average Nigerian is a rich resource for creditworthiness information. However, to see the number of creditworthy Nigerians borrowing from banks improve, CBs will need to embrace alternative data in credit scoring. To do this regulation will need to both increase the scope of CBs, and ensure that sensitive data captured from our digital footprint is protected.
Additionally, CBs need to work with alternative and microlenders. For instance, legislation should be adjusted to ensure CBs capture more data, and the ₦1 million reporting threshold should also be removed.
With the right changes in the way we determine creditworthiness, Nigeria's love for social media could lead to more Nigerians securing business loans and mortgages. Both of which are sure to get a lot of likes when we post about them.