Why communities naturally reduce financial risk

Sometimes an idea is so good that everyone has it at once. One such idea is the ROSCA - a rotating savings and credit association - known as ekub in Ethiopia, cundinas in Mexico, tanomoshiko in Japan and dhukuti or dhikuti in Nepal. At a recent developer meetup I was able to hear from from Matthew Addison, CEO of StepLadder who has built a whole business on this concept, after writing his graduate thesis on the subject.

A form of peer-to-peer lending, the ROSCA relies on the idea of community - working with others to achieve financial goals, where the success of the group is tied to the success of the individuals within the group. Despite being an ancient concept, the strategy of community finance offers insight into how developers can structure applications to reduce financial risk.

Teamwork makes the dream work

The core idea of a ROSCA is that a group works together to set aside money and achieve their financial goals faster than they would alone. For example, 10 people who each needed to save £5,000 for a housing deposit would work together for a 10-month term, each contributing £500/ month. Each month, one member of the group would be selected at random to receive that month’s pot, instantly reaching their personal financial goal.

Eventually, every member will have reached their target. For most, this will be faster and more reliable than saving alone while the group dynamic can encourage reliable participation and reduce risk.

A risky business

There is a fundamental tension at the heart of lending: risk versus service. Lenders exist to increase access to capital for those who need it, but every loan decision must be balanced against the risk of the recipient defaulting. Defaults reduce the lenders’ ability to lend to others in the future, which limits their original purpose and business loan defaults have been rising at the fastest levels since the 2008 crash, leading to a tightening of credit conditions.

The traditional risk calculation is made on available financial metrics that indicate the ability to service a loan, such as credit history, existing savings and business performance data. Even this process is usually a compromise, balancing the lender’s need for information with the amount of time that they, or the customer, can devote to information gathering.

Recent research shows that 38 per cent of UK businesses have chosen to abandon a banking services application in the last year due to “slow due diligence processes”. Financial APIs have helped to increase the speed and efficiency of this process by pulling in existing financial data, but StepLadder has been able to take this a step further by using APIs to act as financial matchmakers.

The group that saves together, stays together

APIs are ideal for collating financial data on existing activity, which helps them expedite traditional due diligence processes. However, there are other factors that indicate a customer’s risk level, such as the context for their credit request, the peer group around them and the consequences of their achieving their goals.

This information is harder to gather automatically due to its non-formatted nature, so StepLadder uses APIs to match their own communities within the platform itself.

StepLadder uses contextual and financial data (from customer input and APIs) to match members with similar goals and needs, creating bespoke communities. Not only does this build in social obligation, it also creates a support network to keep members on track. According to research from National Bureau of Economic Research cited by StepLadder, savings in groups increases the chance of success by 300%. In a StepLadder Circle, 87% of members are in a position to reach their financial goals sooner.

Succeeding together

The key learning for developers is that this doesn’t require any new data. By using existing risk and KYC data, you can reduce risk further by making connections between similarly profiled users. The same concept can also apply to other forms of software risk, such as churn or poor user experience. By connecting users to help each other, they can build stronger bonds through an app, increasing stickiness, retention and satisfaction based on common profiles and goals.