“Globalization is exposing new fault lines — between urban and rural communities...” — Ban Ki-moon
As the world continues to modernize, and globalization becomes synonymous to ‘business as normal,’ banks have shifted their focus in the provision of financial services from small businesses and commercial accounts to multinational lending and complex offerings — offerings often targeted to appease large corporations, high net worth individuals, and large scale, for-profit interests.
This transitional focus has identified fault lines between urban and rural communities, emphasizing the lack of adequate access to basic financial services in agrarian areas. The over 3.41 billion people globally that reside in these regions have an innate desire, much like their urban counterparts, to develop and expand their businesses and economic opportunities in their respective localities.
So how can we extend these financial services in a convenient, transparent, and fair way given the current structure of traditional rural banking? Let’s take a look at what rural banking looks like, where inefficiencies limit its economic outcomes, and how further digitizing rural financial services can invite hundreds of millions of people into a new, unbanked, peer-to-peer economy of financial services.
Introduction to Rural Banking
Rural banks refer to financial institutions established in rural areas (typically agriculturally focused) to support local community members, their agricultural developments, and their locality’s overall economic development. Almost a quarter of the United States population lives in rural communities, and this percentage only increases across the international community (Supporting Mortgage Lending in Rural Communities, Brookings Institute). Contradictory to cultural belief in the U.S., these regions are comprised of large communities of color, which speaks to the macro-economic implications of how these communities fair socioeconomically during times of international recession (The Brookings Institution).
Rural banks typically provide simple financial tools, including bank accounts and loans. In most western nations, these loans usually represent home mortgages or agrarian business loans and are provided with the expectation of an interest payment as well as a relatively good credit assessment of the consumer. In most emerging economies in South America, Asia, and Africa, where the average consumer’s income is multiple order of magnitudes lower than their western consumer counterparts, and consumer credit reports may not be readily available, loans are provided on collateral like land, and, most recently, livestock.
So how do collateralized loans work?
With this type of loan, you can borrow money by putting down an asset as collateral. Commonly referred to as “secured loans,” collateral loans are considered less risky because your lender can take your pledged assets if you default (LendingTree). Car loans and home loans (mortgages) are a perfect example — in both cases, a person has borrowed money while securing their loan with an asset.
Collateralized loans provided by rural banks in emerging economies typically leverage land and livestock as collateral, as many of their consumers either don’t have the credit reference, title documentation, or otherwise means to access other traditional loan services.
Rural Development, Consumerism, & Economic Growth
According to development economics, the main factors to promote economic growth can be divided into three aspects (Yang, 2010):
Growth caused by capital input
Growth caused by labor force input
Growth caused by comprehensive elements such as management, science, technology and education
Proposed solutions that fuel such developmental growth must attend to the diverse array of financial demands in rural communities, including that of rural consumers, small and medium enterprises, and rural local governments.
The rural consumer segment is divided across three core consumer groups:
Rich Rural Consumers — A small proportion of rich rural consumers are mainly non-agricultural by replacing the traditional agricultural production with new agricultural production (such as cultivation). They have great capital needs and definite plans for their capital use as well as the repayment term and hence little risk (Yang, 2010)
Average Rural Consumers — Average rural consumers who take up a large proportion of the total rural population, have financial demands for both agricultural production (chemicals, seeds and so on) and living (children’s education, medical health). Due to the short cycle and strong seasonality, they mainly turn to their relatives and friends and they can repay their loans punctually if turning to banks (Yang, 2010)
Impoverished Rural Consumers — Poverty stricken households have financial demands for medical care, food, housing, and so on, which embody great risks due to the large amount of capital and the long repayment term (Yang, 2010)
Small and medium enterprises typically employ the vast majority of laborers in rural economies and can also be divided into three sub-categories, including agricultural materials and production companies, supply and marketing companies, raw materials companies, and industrial/mining companies. Generally, agricultural companies call for less capital in their establishment and operation while the latter two call for either larger scales or a large amount of start-up capital and therefore need strong financial basis(Yang, 2010).
Local governments typically seek effective investment and financing channels more broadly to guarantee sound agriculture development and to provide necessary public materials (Yang, 2010).
Financial Difficulties of Rural Consumers
The financial difficulties that rural consumers face on a global scale can be divided into the following obstacles:
Inconvenient travel time to the nearest bank to take advantage of available financial services
In the presence of moral hazard, farmers will prefer not to borrow even though the loan would raise their expected productivity and income (Crop Price Indemnified Loans for Farmers). There is a well-established culture of ‘risk rationing’ across households who never tried to access the formal market because of the high risk associated with borrowing due to consequences of default,
Higher interest levied by traditional banks to mitigate loan risk associated with rural consumers, who often do not have a ‘credit score’ or proper collateral to offer
Inability to establish future markets and other risk management tools to decrease price variability in emerging economies due to a lack of infrastructure to support traditional market architecture (Crop Price Indemnified Loans for Farmers)
Disproportionate and systemic control of the liabilities of minority communities (rural, ethnic, or otherwise) due to predatory state policies
Social collateral, or ‘lending relationship strength,’ isn’t taken into consideration in westernized markets, creating a cultural dissonance between financial tools available and the people looking to use them. Relationship lending dominates in economies where the likelihood of strategic default is high because of an underdeveloped financial system with low transparency and weak legal enforcement (Egli et al., 2006).
Information asymmetry between banks and farmers
Lack of relevant education available in rural areas to decrease potential collateral requirements
Available collateral documentation is not accepted by local lenders, or leads to a very slow legal process (particularly regarding land rights)
The common theme and message across these market obstacles is clear — the traditional mechanism of finance cannot adequately support rural consumer needs AND maintain a risk mitigated, capitalistic strategy. So how can we begin to disinter-mediate this operational friction within rural markets?
Tokenization of Non-Fungible Assets
As a very quick introduction before we move forward, we’ll need to touch on Non-Fungible Tokens, or tokens that represent non-fungible assets (otherwise known as ERC721 tokens). Examples of such tokens are as follows:
Tokenized Real Estate — Meridio
Meridio converts individual properties into digital shares on the blockchain, seamlessly connecting diverse investors and asset owners to invest and trade. Home equity is a non-fungible asset that, traditionally, requires a massive amount of resources and risk to own. The paperwork associated with homeownership and every real estate transaction is far too much for any individual consumer to process, and there are many intermediaries between the initial offer and the closing agreement that inflate the cost of ownership. By tokenizing equity, and effectively securitizing ownership of a single property, the barrier to investment entry almost disappears, and proof of ownership and sale are all immutably recorded on the blockchain, so there is no need for keeping your fractional title in a lockbox.
Tokenized Digital Assets — Cryptokitties
Cryptokitties is another example of non fungible tokens. In this case, we have unique digital assets in the form of cute kittens. The price of these assets are far more speculative than real estate, but they represent a perfect example for use case scenarios like artwork, music, and other non-fungible assets that draw their value from both cultural relevance and subjective valuation.
So if there’s already tokenized real estate, and tokenized kittens, why can’t there be other tokenized forms of non-fungible collateral operating within the rural banking space?
Digitizing the Rural Bank Loan Process
Many of the inefficiencies of rural banking stem from risk mitigation obstacles and lack of consumer access. Credit score structures, much like the FICO score in the United States, are few and far between in emerging economies, and oftentimes even those scores, when available, can be extremely subjective depending on the consumer’s ethnic background and credit security (if identity theft occurs). Even when proper credit and collateral is established, the process to prove ownership of such collateral and settle the transaction to afford a loan is a lengthy and stressful process.
By tokenizing commonly available forms of collateral in rural economies, like land and livestock, and developing commercial, monetary policies that govern expectations of the settlement process and which data must be available on the public chain to more easily verify asset ownership, the rural financing market can become much more liquid than it is now and rely on new forms of loans that aren’t issued just by central authorities.
In my article, Unbanked for Good, we delved into the high smartphone penetration in emerging economies, and the likelihood of these regions to leapfrog traditional methods of sending and accepting capital as they sprint towards a mobile-first, cashless society.
Therefore, it is no stretch of the imagination that, with the increased prevalence of stable cryptocurrencies like DAI, the development of new collateral assessment vehicles, and the development of new, legally recognized asset tokenization processes, that a rural consumer could:
Document their available assets. This could be livestock, land, even recyclables — any material that could be commercially converted to value without too much operational friction
Provide available means of ownership for those assets (or receive proof of ownership on chain when they acquire new assets)
Enter a contract to tokenize their assets and undergo an assessment for the fiat value of that potential collateral
Use those non-fungible tokens as collateral to apply for a loan
The goal — for this whole process to take place via their mobile device. Of course, such a process would (but doesn’t necessarily have to) rely on self-sovereign identity (which, at the start, could just be a public address with a certain transaction volume) and proof of location (see FOAM), among other elements, but the possibility is REAL.
Lastly, the loan will no longer need to be disbursed from a central authority, and information asymmetry will become a thing of the past. The process of ownership and asset-value assessment can be, in many ways, automated. Of course, guiding fiscal policy will still be necessary to protect both consumers and commercial entities. Peer-to-peer loaning systems could provide liquidity between western localities and rural economies, where the exchange of stablecoin loans for non-fungible token collateral occurs in mere minutes to represent international, collateralized loans. Liquidity to rural areas would no longer be in control by municipal banks, and people could affect fiscal change a world away from each other. Smart contract protocols could then evaluate on-chain history to more objectively determine portable credit scores to best mitigate risk of default or perjury in a proposed transaction. This is the ideal potential for social mobility across the urban-rural gap.
Rural Inclusion & New Economy Market Making
“New markets could be created by rural potentials, which could lead to rise in the employment.” — A. P. J. Abdul Kalam
There are revolutionary markets to be made by the tokenization of non-fungible assets. Increased liquidity in systems gridlocked by operational friction will release trillions of dollars in value into the global economy and, hopefully shift the world’s earning gap for the better. Whichever the case, it has become quite clear that traditional mechanisms of finance do not work for those who need it most, and it is crucial to dis-intermediate these systems so that we, as humanity, achieve equitable access to financial instruments and the lives that they can enable.