Managing Risk through Innovation, Part 2: Borrower and Trustee Selection
This is Part 2 of a three part series on Kiva Zip’s risk management philosophy, policies, and procedures. Part 1 covered delinquency management. Part 2 covers our borrower and Trustee review process. Part 3 will cover how lenders can participate in risk management.
Kiva Zip primarily assesses potential borrowers based on recommendations from Trustees, individuals and organizations that are passionate about supporting entrepreneurship, small businesses, and economic development within their communities. This blog post outlines the requirements we’ve developed for becoming a Kiva Zip borrower and Trustee.
When Kiva Zip first launched, we had a lot of questions about whether using Trustee recommendations to underwrite loans could work. Early on, our team tried to aggressively experiment with onboarding different types of Trustees to understand the characteristics of successful Borrower-Trustee relationships. As Kiva Zip has grown and matured, we’ve become more rigorous and structured with the borrowers and Trustees we post on the website. We’ve developed a set of general requirements that guide us in those decisions.
To be posted onto Kiva Zip, borrowers must meet three requirements that we verify through self-reported data, online research, and third party services.
Financial Stability: To be approved for a Kiva Zip loan, borrowers cannot be under serious financial stress. That means that they cannot be over-indebted or currently in foreclosure, in collections, or under any liens. We aim to post borrowers that have a monthly debt-to-income ratio of 30% or lower. While we do not reject any borrowers solely because of a low credit score or past bankruptcies, we reject borrowers that have been convicted of a financial crime within the past 7 years.
Trust Network: Borrowers must also demonstrate that they have a network of people that will vouch for their character. Most frequently, this is done through an endorsement from a Trustee that has a strong relationship with the borrower and can credibly assess the viability of the business. We’ve also been testing other ways of meeting this requirement, such as requiring borrowers in the US to connect with us on social networking platforms or to invite a number of people to lend to them.
Social Good: Kiva Zip requires that all loans be socially impactful. This requirement can be met through several different causes: the borrower might serve a low-income neighborhood, be without access to traditional financial services, or have a specific social mission like improving access to nutrition or helping disadvantaged communities.
While the broad categories of these requirements are consistent in both the US and Kenya, different standards apply to each country. For example, we do not require a Kenyan borrower to share social networking information. Standardized information for borrowers in Kenya can be difficult to attain, so we rely more heavily on Trustees. Further, in the US, we accept a wider range of Trustees to establish a borrower’s trust network.
Understanding how to select qualified Trustees has been one of our biggest challenges. Because the Trustee role is a new concept, we’ve had to aggressively experiment with different types of Borrower-Trustee relationships and have received mixed results. From our experiences over the last two years, we’ve narrowed down our selection process and improved our performance quite substantially.
We’ve found that the most important factor is that Trustees be aligned with our mission and values. They need to create a positive social impact in their communities through the borrowers they support, and positive social impact must be the primary motivation for any endorsement. In the past, when Trustees have had financial incentives or other motivations to endorse borrowers - such as a franchiser endorsing franchisees - we’ve seen very poor results.
We also expect Trustees to have enough resources to support borrowers through the life of the loan. Small businesses face challenges on a constant basis. Without a network to which borrowers can turn for advice and support, the success of their business can be jeopardized.
In order to ensure that Trustees share our mission and are equipped to support their endorsed borrowers throughout the life of the loan, they must complete an application and create an online profile. In addition, there are other country-specific requirements.
In the US, we require individual Trustees and Trustee organizations with 5 or fewer employees to go through an online identity verification and background check. Individual Trustees must have at least two years of experience in a field such as economic development, technical assistance, or small business advising. In Kenya, many Trustees go through an on-site visit. The purpose of the on-site visit is to verify the organization’s mission and resources where the process is difficult to complete online or where we lack third party references.
With so many people across the world locked out of traditional financial services, new methods of providing capital to promising entrepreneurs and small businesses must be developed. Over the past 30 years, the concept of trust-based lending has largely disappeared. Particularly in the US, the rise of retail banking and credit scoring has based lending on complex algorithms that few people understand. We believe that using social capital to underwrite loans is a better way select borrowers and expand access to capital. We imagine Kiva Zip as a resource where anyone with a solid business plan and a trust network can access the capital needed to grow his or her business.
Over the past two years, Kiva Zip has tested the Trustee endorsement model as one form of social underwriting. In the future, we see a number of other possible methods that can build on and develop this concept. Perhaps we will build a system where multiple people crowdsource endorsements for a single promising borrower. Or maybe we will try to leverage existing social networks and online data to select borrowers with strong trust networks. Even asking the Kiva lender base to play a heavy role in vouching for potential borrowers is something that we’ve considered.
Developing a scalable, effective method of social underwriting opens enormous possibilities for not only growing Kiva Zip but also changing how the world thinks about creditworthiness. While Kiva Zip has faced lots of challenges and has made many mistakes, we believe that it is a change worth fighting for.