For most of modern history in developed countries, when you needed a loan, you turned to a bank. Conventional wisdom said turning to friends was a disaster and bank was the way to go.
Recently though, there's been some pretty interesting questioning of that model. Everything from Lending Club to KickStarter to SoFi has made us question whether banks are always the right place to turn. (SoFi even cleverly memorialized the trend with their recent #dontbank campaign).
Since conventional wisdom says don't mix money and friends, we thought it'd be fun to look at some simple but profound evidence that it's not only possible for people to lend directly to each other, but it's more effective and, if you take a wide aperture, actually more common.
Today, we'll open up the data on what's going on in other countries. Next week, we'll consider what happened before there were big banks and Wall Street.
The Community Bank
In developing countries, a few interesting systems — for both savings and lending — have been built on the principles of community and social capital. These community-driven institutions have become ubiquitous, with millions of people organizing themselves into them every year.
For example, Rotating Savings and Credit Associations(ROSCAs) and Accumulating Savings and Credit Associations (ASCAs) are self-formed groups of individuals who meet periodically, where everyone pays into a group pot, and one person takes home the whole pot when it's his or her turn (ROSCAs), or the pot can be borrowed from on a per-need basis (ASCAs).
But perhaps the best example to consider is Savings Groups. Their setup is as simple as their name. Groups within a community come together and define a savings plan for each member. If a member needs to borrow they can borrow from this pot at a pre-defined interest rate. At the end of a set time frame, the principal and interest is paid out to each member according the amount they put in.
There's no contract, it's all based on social capital and trust.
While the idea might seem quaint and mundane, the results have been shocking. In an extensive study by the Gates Foundation that covered 60K groups and 1.4M people:
- Annual return on assets was over 40%
- 60–70% of members were active borrowers
- Loan size was generally between 6% and 11% of per capita income (at 5–10% interest)
- Over 95% of groups lasted more than five years
Conventional wisdom is skeptical that people can lend to friends without all the trappings of a contract, credit scores and collateral. We hear time and time again that people will just take the money and run, right? It turns out, there's no evidence that's true. Repayment rates in these community groups, if anything, are higher than what we see with banks. And the borrowers here really need the money.
Apparently trust and social capital are stronger than conventional wisdom thinks they are.
So do we need banks? They definitely serve a purpose. But are there effective and proven alternatives to the banking model? Absolutely. Ones that can give us better returns while keeping everything 'in the family'.
That's part of the reason we built Frank — because we know how effective it can be.