Are you Creditworthy? Because it Really Matters

Having been a lender for the last 12 years, I have learned that selling money is the easiest thing one can do. If I went to the lobby of our building and set up a desk and a placard that reads, “Borrow 5,000 shillings today with your ID only!” I would be willing to bet anything that in no time I’d have a line that would be reminiscent of voting in an election and the demand would be sustained until I ran out of money for lending. Which then leads to the obvious next question, when would all these clients pay me back? And would I be profitable?

Some clients would payback, but not all. Profitability would only be determined by the price I charge. If I charged 1% per annum, the loss would be so big that, one-day of sales would be all I’d be able to do. If I charged 100% per month, I’d only break even if 50% of the customers paid their money back. Therefore, lenders devise ways to mitigate risk and get the best return on investment (ROI). There are several ways of mitigating risk but the four I’ll mention are the initial strategies lenders use to mitigate risk:

Photo credit: Fort Bragg MWR

1. Know Your Customer (KYC) – In the case above, all that was required to get a loan was a National Identification Card. This does not give all the necessary details to mitigate default risk. If you have ever borrowed from a financial institution, they ask for proof of your address like a bill. This is usually used to confirm where one lives so that in the event of default one can be traced. In some instances, some lenders even make a site visit.

2. Affordability – This is the measurement of the amount of money an individual can afford to borrow. A loan must be paid from cashflow, whether new or existing. Thus, even if one may want to borrow Kes 10 million but their new or existing cash flow cannot sustain the requested amount, a good lender would then propose an amount that one can afford to repay comfortably.

3. Collateral – This is usually necessary after the first two have been ascertained. Collateral is the lender’s way of ensuring that if in default, the lender can liquidate the collateral and recover the money borrowed plus other accrued expenses. The irony about collateral is that the lower the loan amount, the more difficult it is to collateralize a loan.

Facilities advanced to limited companies require the perfection of securities as well as registration of debentures which could either be floating or fixed. In instances where land is used as security like in mortgage financing the process of perfecting the security is quite engaging since the land has to be valued by an approved valuer before the title is registered at the land’s office, after which disbursement of the requested amount can be done.

4. The Credit history of the borrower – Be it a person or company, the history of the borrower is probably the most important variable measured. The Yemeni have an interesting way of determining potential suitors for their daughters – they ask the suitor whether they owe anyone, If the answer is no, it is taken that the suitor is not trustworthy. The idea behind it is if you are worthy to marry my daughter, why is it that no-one TRUSTS you with a loan?

This is why repaying a loan is important, and with the rise of Credit Reference Bureaus, it is now much easier to determine creditworthiness.

Debt can be forgiven, but very rarely. What is more common is the waiver of accrued fees and penalties. Usually, this only happens if a client communicates with a lender in a good time and not after default.

As micro-lenders we have been able to do all the above on an android application and the science behind how we mitigate risk has been not only exciting but quite eye-opening. Trust is the most important variable when lending money to customers, and the more a lender trusts you the better for you in the long run!

Build a relationship with your lender from the very beginning and you will find that same lender will be your partner for a long time.

Author: Kevin Mutiso