> Posted by Jeffrey Riecke, Communications Specialist, CFI

Are interest rates necessary for loans? What about strict repayment structures? Recently, a colleague emailed me about Zidisha, an online lending platform that’s harnessing expanding internet penetration rates to offer lower-cost peer-to-peer loans. Zidisha adopts a handful of approaches that depart from how loans are typically served to the base of the economic pyramid, including in terms of interest rates and repayment structures. I wanted to learn more, so I reached out to Julia Kurnia, Founder and Director of Zidisha, for a quick conversation. The following is an edited version of our exchanges.

First off, I’d like to say congratulations on all of Zidisha’s success. I understand that in its six years, Zidisha has disbursed roughly $6 million in loans to 40,000 people. By way of background, maybe you could start by offering a quick description of Zidisha?

Zidisha is a peer-to-peer (P2P) microloan crowdfunding platform that lets ordinary people like you and me send zero-interest microloans directly to lower-income people in developing countries.

What makes Zidisha unique is that we don’t work through local banks or other intermediaries. Instead, we target today’s generation of internet-capable microfinance borrowers, and connect them with the lenders directly. Borrowers post their own stories and loan proposals, and dialogue directly with their lenders via our website.

Eliminating local intermediaries allows us to provide loans at far lower cost to the borrower than traditional microloans. This amplifies the social impact of the loans, as borrowers keep the profits they generate instead of paying high interest rates to cover local banks’ operating expenses.

What was the inspiration for Zidisha?

About 10 years ago I spent a summer helping a nonprofit in Senegal raise microloan capital through Kiva, a crowdfunding platform for local microfinance organizations. Though Kiva lenders provided funding at zero-interest, we found that we would have had to charge the borrowers exorbitant interest to cover our operating costs.

It turns out we weren’t unique. Interest and fee rates of 30 – 40 percent are typical for microloans in developing countries, and even the zero-interest capital crowdfunded at Kiva is passed on to borrowers at average interest rates of over 30 percent. Most of this cost comes from brick-and-mortar offices, loan officers, and administrative staff, which are expensive relative to the small loan amounts. As a result, many of the world’s poorest people are paying the world’s highest costs for small business loans.

I then spent several years facilitating U.S. government grants to grassroots initiatives in Africa. During that time, internet access improved dramatically in even the poorest African countries. Cheap cybercafes became ubiquitous in urban areas, and a new generation of young adults who had grown up using Facebook was entering the working population. Back at my old nonprofit in Senegal, these internet-savvy individuals no longer needed to pay high loan administration costs for us to communicate with Kiva lenders on their behalf. They were capable of participating independently in a direct peer-to-peer lending marketplace. Zidisha was founded to give them the opportunity to do so.

After six years of learning and iterating on our lending model, we’ve been able to get the cost of loans to the borrower down to just 5 percent. We don’t have loan officers or any employees in borrower countries. Most of the cost is website development, money transfer fees, and automated SMS charges.

Although internet penetration is increasing rapidly, the concept of an online peer-to-peer lender must seem strange to many lower-income, unbanked individuals. What is Zidisha’s approach for attracting borrowers and how has this evolved over the years?

We don’t do any marketing to prospective borrowers.  We’ve found that people who have never heard of Zidisha tend to dismiss us as a scam: the idea of getting money from the internet seems absurd, and our low fee rate makes the loans sound too good to be true.

When we begin lending in a new country, a local volunteer is usually needed to persuade the first 50 or so borrowers to sign up. After that, though, word of mouth takes off and is usually sufficient to drive continued growth without further outreach on our part.

Word of mouth growth has also helped us leverage the knowledge of existing borrowers to vet new applicants. A few years ago, we introduced a referral program whereby current borrowers in good standing may send a limited number of invites to trusted acquaintances. Those who join with an invite enjoy a higher starting credit limit. Over time, this encourages networks of responsible borrowers to grow and become dominant.

This is an interesting connection between referrals and credit risk. How is Zidisha able to forego interest rates?

Limiting the net cash disbursed to unproven first-time borrowers is an important credit risk control mechanism for us. The default starting credit limit is very small – usually about $10 for applicants without an invite. Subsequent loans increase at a fixed rate, on the basis of prior loan amounts repaid on time.

If an applicant wishes to progress to larger loans more quickly and can afford it, he or she can opt to make a payment into a reserve fund in return for a higher starting credit limit. Though the net amount he or she receives from the first loan is still only $10, the second and subsequent loans increase based on the larger amount he or she repaid initially.

The amounts paid into the reserve fund are pooled and used to refund lenders when loans are not repaid on time. This makes it possible for lenders to preserve the value of their lending capital without charging interest.

Zidisha also has a unique approach to loan repayments. Can you describe this approach and the logic behind it?

One of the most challenging problems for microfinance services is the need to balance repayment discipline with flexibility. Flexibility is important because most low-income people in developing countries don’t have salaried jobs, insurance, substantial savings, or other safety nets. Self-employment incomes tend to be erratic, and expensive health and other emergencies happen relatively frequently. An ethical microfinance service needs to accommodate this reality, rather than force people to choose between basic livelihood and repaying a scheduled loan installment. But too much flexibility rewards free riders, who can start a spiral of defaults that endangers the long-term viability of the lending program.

The repayment policy that has evolved at Zidisha requires strict adherence to due dates, but offers more flexibility on installment amounts than is typical of other lending programs. At the time of application each borrower chooses the installment amount he or she schedules to fall due each week.  If cash flow is disrupted during the course of the loan, the borrower may log into his or her account and adjust the installment amount to anything that is easily affordable, as long as it is not zero. As long as the installments are paid on time in the adjusted amounts, the borrower preserves the good on-time repayment record needed to access subsequent loans. The borrower may then increase the installment amount when financial conditions improve.

This policy allows borrowers to maintain their good track record and habit of repaying weekly, without materially affecting their finances during times of hardship. We’ve not seen borrowers abuse this flexibility by taking excessive time to repay. Most repay as quickly as they can afford, in order to access larger subsequent loans.

In a recent piece you wrote for The Huffington Post, you described Zidisha as having “more in common with eBay than with Grameen Bank.” That said, do you see any lessons from Zidisha’s experiences that’re applicable for microfinance institutions and traditional brick-and-mortar financers?

First, it’s important to note that Zidisha serves a niche market.  Most people in developing countries still do not use the internet, and couldn’t participate directly in an online lending platform.

That said, it’s a niche that is growing very quickly and will soon become dominant. In that respect, Zidisha is a bellwether of what may become mainstream in microfinance lending a decade or two from now. Traditional microlending institutions should be watching this trend and preparing to move more of their services online when market conditions allow. The more microlending services are decentralized to borrowers via technology like smartphones or computers, the more cost savings can be realized and passed on to borrowers in the form of lower interest rates.

Even microfinance institutions whose clients are not online can learn from Zidisha’s experience. For example, we’ve shown that it’s safe to offer borrowers more autonomy in designing and adjusting their repayment schedules. In general, we try to let the borrowers direct their loan investment and management as much as possible, while protecting the integrity and financial viability of our lending community. We’ve found that once basic fraud protections are in place, trusting people’s good judgment and honesty leads to responsible participation.

For more information, visit Zidisha’s website.

Have you read?

FinTech for FI2020: A Conversation on Aligning Technology and Partnerships for Financial Inclusion

Four Barriers – and Four Solutions – to Financial Inclusion Through Payment Innovations

Financially Included Through Crowdsourced Financing?