Western lenders have forgotten responsible lending, online social networks have the potential to bring them back to the basics.
In the Early 1900 Mr. J.P. Morgan was asked what is more important in lending, assets or income? His response, “the character of the man”. Mr Morgan knew a little about lending having financed much of the industrial revolution. Morgan knew “Character” is the cornerstone of lending. He knew, going back to biblical times, credit was based on the reputation in the community.
Lenders lost their way in the 1950s as the very nature of community changed. Harvard Professor Robert Putnam documents the change in his book Bowling Alone: The Collapse and Revival of American Community. Putnam points out that suburbia, the automobile and television all converged to change how industrialized societies interact. Western Societies became less connected with their neighbors. One of the results is that banks turned to faceless ratios and FICO scores as the core of their underwriting process. Furthermore, lending based on personal relationships did not scale well in the age of mega-corporations. The result was bad lending and ultimately the recent sub-prime crisis (at least some of it).
Bankers have forgotten how to use character as the foundation for credit.
The good news is the “lost art of character lending” is being rediscovered in the emerging markets where family and community bonds remain vibrant. The strength of the community is reflected online where social network use often exceeds activity in the west. Involving the community is the key to unlocking the riddle of character.
The rediscovery of character based lending all started with Professor Yunus desire to help the extreme poor in Bangalore. Yunus hypothesized that if members of the community were willing to vouch for each other it would be an effective way to distribute credit. He was right. It turns out that people's willingness to vouch for each other is driven by character, and the result was the Microfinance Industry. Yunus’ customers did not have access to electricity, let alone FICO scores, but thanks to Yunus they could access capital to improve their lives. Today the Microfinance industry successfully lends over $50B a year, and Professor Muhammad Yunus won a Nobel Prize for his positive impact.
Globally, the default rate in the Microfinance industry is around 2%, outperforming most western consumer lenders. Clearly, lending based on character, works. Yet $50B a year is not much in a Multi-Trillion-Dollar debt market. That’s because until recently, Microfinance lending was only used by the ultra poor, and had to be face-to-face. Social networks like Facebook, Google+ and Linkedin can change all that.
Interested in empowering the emerging market middle class and building a new global financial infrastructure based on character? Why not join our team at Lenddo.com?
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