April Rinne: What Collaborative Consumption and the Sharing Economy Can Learn From Microfinance
Microfinance is the provision of financial products and services to economically active poor people who for a variety of cultural, social, gender-related and other reasons are excluded from the mainstream financial sector, especially in the developing world. The microfinance sector has grown significantly over the past few decades and in 2006 Muhammad Yunus, considered by many to be the father of modern microfinance, was awarded the Nobel Peace Prize for his pioneering work in fostering access to finance as a path towards more peaceful relations.
At first glance, it may seem that microfinance and the Sharing Economy have little in common. Microfinance focuses on poor people in the developing world. Women represent the vast majority of microfinance clients, and many loans are for working capital assets such as livestock and small shop supplies. Ironically many microfinance beneficiaries share out of necessity — as they have done for generations — though they wouldn’t necessarily think of building a business around it.
However, this first impression is incomplete. Further investigation reveals a multitude of similarities and — perhaps most importantly — key lessons that the Sharing Economy and collaborative consumption could learn from microfinance:
Empowerment: At their core, both microfinance and collaborative consumption enable and promote empowerment of individuals. Responsible access to finance unleashes a positive chain of ripple effects: livelihood, income generation, and a brighter economic future for clients, their families and communities.
Collaborative consumption achieves similar ends. As Rachel Botsman says, “My core driver is how [collaborative consumption] empowers people. It empowers people to tap into skills and talent that they have but haven’t found opportunities to make money from before. It empowers people to be in control of their jobs and their lives. It empowers people to make all new kinds of connections that are often quite tricky to make.” Technology has democratized, economized and facilitated the ways in which ever-increasing numbers of people can transact with one another and create new value.
Trust, Reputation & Social Collateral: Microfinance and sharing-based businesses depend on these essential characteristics for their very survival, in addition to their popularity. No rational person would make an uncollateralized loan to a poor person she doesn’t trust. In microfinance, your reputation substitutes for credit history (because the latter doesn’t exist). The group lending model of microfinance, in which each member of a group is responsible for ensuring that all members repay their loans, is premised on “social collateral”: you’re banking on an individual’s trustworthiness within society, rather than her material assets, as the best indicator of whether she can and will repay a loan. As a result, social standing among peers — especially within tight-knit communities — is built over time and reigns supreme.
Similarly, in the Sharing Economy this kind of social fabric and “trust barometer” can be created thanks to new technologies. Engaging in collaborative consumption — and getting used to it — lowers the trust barrier over time. Botsman summarizes it well: “The first few interactions people go through typically involve quite a few exchanges. Once they figure out that most people are trustworthy and that the idea works, the amount of trust features they use for future interactions declines.”
Unpacking Real vs. Perceived Risks: Early in the growth phase of microfinance, potential investors often shied away from transactions due to a variety of perceived risks and unknowns: how can I trust that clients will repay? How do I trust a small financial entity halfway around the world that I may have never even met before? How can I be confident that my investment will lead to poverty alleviation, and funds not misused?
I served as legal counsel for several early microfinance deals in which the risk disclosure language used in offering memoranda and other documents exceeded what was customary in mainstream exchanges on Wall Street. This was because investors were fearful of what they viewed as an untested sector, yet they also understood the power of microfinance as a business proposition as well as a poverty alleviation tool.
Over time, microfinance institutions (MFIs) grew sustainably and access to microfinance products and services continued to be in demand by clients. It turns out that economically active poor people are overwhelmingly reliable, smart, committed and entrepreneurial. The fact that they lack physical assets (or “wealth” as traditionally defined) is by and large an overstated, perceived risk; microfinance repayment rates often hover around 98 percent — rather remarkable when compared to consumer credit statistics among wealthier people. Gradually this lack of physical collateral became less important to investors because they started to understand — and importantly, observe first-hand — that their original assumptions around transactions in which trust and social collateral are not principal driving factors break down in situations where they are. In retrospect this conclusion seems simple; however, it took repeated experience to get there and did not happen overnight.
Now shift to today’s Sharing Economy. We see a strikingly similar set of circumstances unfolding, and I believe we can expect to see many more, especially for those companies reaching scale. Many people are skittish of sharing resources with someone they don’t know: what if someone runs off with my shared prized possession, or damages it, or doesn’t return it on time? What if I don’t get the quality of service I expected? In short, how can I trust strangers?
Yet if we take a step back, we see that unpacking real versus perceived risks is not rocket science. First, a lot of risks are simply perception rather than fact. For example, you trust people whom you don’t know every day without incident — like the bus driver who takes your kids to school, or the person who cleans the office. Further, there are plenty of ways to mitigate a variety of risks both formally and informally. At the end of the day we need to develop robust connective tissue and norms within the Sharing Economy akin to what microfinance clients rely upon — with considerable success.
The Importance of an Effective Enabling Environment: A phrase like “enabling environment” often makes a person’s eyes glaze over. Yet in my opinion, perhaps nothing could be more important to the long-term success of collaborative consumption and the Sharing Economy overall.
Broadly speaking, enabling environment refers to the legal and regulatory framework within which a business, sector or idea is allowed to manifest and operate. It includes laws and policies that permit, encourage and mainstream the creation of companies and supporting infrastructure, as well as promote good governance and foster a socially responsible community of customers and beneficiaries. Importantly, an effective enabling environment allows both established interests and new and start-up initiatives to thrive alongside one another.
I was fortunate to have a front-row seat for many enabling environment discussions in microfinance. Leaders and policy-makers in developing countries wondered and worried: how do we regulate microfinance — a new and promising but largely untested sector — in a way that allows it to grow responsibly, while at the same time ensuring basic protection of poor people, a competitive marketplace, balanced growth of the commercial banking sector, and further financial innovation?
As Yunus said in early days, “Existing regulations are designed with commercial banking in mind, but microfinance requires a dedicated regulator and a relevant set of rules. Commercial banking is like a super tanker whereas microfinance is like a dinghy boat with which you can reach small corners. If you design a dinghy boat with the architecture of a supertanker, it is sure to fail.”
Indeed, Yunus is right — and many microfinance practitioners and developing countries have paid attention. It turns out that the best enabling environments result from a blended set of actions including customized laws for microfinance, a variety of exemptions, prudential regulations, and feedback loops that allow for stakeholder input and refinements over time.
Many of the experiences and lessons from microfinance apply remarkably well to the Sharing Economy. From a legal and regulatory perspective, today’s Sharing Economy is where microfinance was about 15 years ago. In the coming years, I envision an enabling environment for the Sharing Economy to evolve that provides a “runway” for new collaborative consumption companies to grow and incentives for established companies to innovate. As I mentioned in an earlier post, a successful enabling environment should include certain exemptions where appropriate (to regulate a spade as a spade), user feedback loops (to ensure the laws and regulations have the intended effects) and deliberate iteration (to facilitate further improvements).
It’s going to be an extremely exciting process to figure out these details — at local, state, national and even international levels — and I am eager to dive in and do just that!
Diversity of Models, aka There’s Room for All: Microfinance comes in many flavors. Some MFIs offer credit (small loans) only, while others offer savings products, insurance, remittance services and mobile banking. Moreover, some MFIs are for-profit institutions with foreign investors and private equity, while others are non-profit organizations that mobilize primarily local capital, community contributions and grants. Importantly, this diversity is a strength; each MFI model has its own set of advantages, disadvantages, opportunities and limitations. It also fundamentally relies on enabling environment conditions.
We see similar trends arising in the Sharing Economy. One needs to look only as far as Airbnb, Couchsurfing and Freecycle. Airbnb is for-profit and VC-backed; Couchsurfing is a for-benefit corporation (aka B-corp), largely based on reciprocity and with a clear social mission while allowing financial return as well; and Freecycle is fully not-for-profit and excels at non-monetized exchange.
Which model is ‘better’ depends on who you are and what you want. Airbnb taps into the commercial space, whereas Freecycle nudges barter and gift economies and Couchsurfing occupies a unique place in between. The key is that each model creates value, harnesses underutilized assets to work, fosters local connections, community and economic activity. All of them represent new ways of transacting, seeing the world, and unlocking opportunity. There is plenty of demand and even more room for complementary growth. This is not the time to worry about crowding out. Rather, we should focus on being inclusive and recognize that — like with microfinance — “the sum [of these diverse approaches] is greater than its constituent parts.”
I have spent the better part of the past decade focused on microfinance, typically in combination with some other focus area: serving as legal counsel to investors (from VC and investment banks to philanthropic foundations); teaching policy-makers about building enabling environments; and forging partnerships with MFIs to develop financial solutions for water, sanitation and other essential services. I’ve spent countless hours facilitating cross-sector linkages and tapping into new areas for innovation. It’s been a fascinating and rewarding journey.
As I look at the Sharing Economy universe today, I have a distinct sense of déjà vu and am incredibly excited about what is ahead. Collaborative consumption stakeholders — whether start-up ventures or established companies, city leaders or national governments, environmentalists or community groups — have much to gain by looking at other successful examples of disruptive innovation. Microfinance is one such example, whose lessons are ripe for sharing.
This post originally appeared in Shareable.net on November 27, 2012: http://www.shareable.net/blog/lessons-from-microfinance-for-the-sharing-economy
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