Flipping the Switch: How Locking Assets Unlocks Credit for the Poor

With the flip of a switch, a growing number of financial service providers are transforming simple items like solar home systems and smartphones into cash loans for low-income borrowers. The secret to this transformation is remote lockout technology, which allows lenders to switch off assets when a customer fails to repay — turning household items into collateral. Now, a new study out of Uganda offers strong evidence that this technology can enable providers to profitably serve low-income customers whose lack of more traditional kinds of collateral has long excluded them from access to credit.

Study demonstrates potential of lockout-enabled loans

With the support of the Harnessing Innovation for Financial Inclusion (HiFi) program, researchers from UC Berkeley and Washington University partnered with Engie Energy Access (formerly Fenix Intl) in Uganda to conduct a randomized control trial on the impact of Energy Access’s novel ReadyPay School Fee Loan product. The product, initially designed with CGAP under the HiFi program, allows Energy Access customers who have repaid their solar home system loans to use their equity in the systems as collateral for cash loans to pay school fees.

As we wrote about in our earlier blog post, the study confirmed that the loans had a significant positive impact on education indicators like school enrollment and expenditures. Children in households that received a school fee loan were more likely to enrolled in school compared to children in the comparison group, and the results suggested that the loans cut the share of children out of school by half. Moreover, these households increased their education-related expenditures by 36 percent.

To understand lockout technology's impact on the performance of ReadyPay loans, Energy Access offered some customers loans under the condition that should they become delinquent, their solar home system would be shut off until they met their payment obligations. Another group of customers received loans without the lockout condition.

Ultimately, the group of loans with the lockout condition (referred to as "digital repossession" in the study) outperformed the other loans. One hundred days from loan origination, the average repayment rate was higher by 13 percentage points, and the loan completion rate was higher by 10 percentage points. The loans with lockout technology also proved more profitable than those without, increasing the internal rate of return on the loans by 3 percentage points.

That said, the researchers also observed that customers were generally less willing to accept lockout-enabled loans, as shown in the chart below. One explanation could be that the threat of lockout encourages self-selection, with borrowers who expect to have trouble meeting their repayment obligations choosing not to take the loans. But as CGAP has warned in the past, customers generally dislike the prospect of having their lights shut-off, even as a condition for obtaining much-needed credit. That doesn’t necessarily imply that they are unwilling or unable to repay (although that may be the case in some instances). Rather, it could reflect risk aversion within a population that struggles to manage irregular incomes and unexpected shocks like illnesses or droughts.
 

A new opportunity to drive sustainability and impact at scale

These findings demonstrate how lockout technology can overcome barriers to sustainably financing low-income customers. Although CGAP research shows that prospective PAYGo solar borrowers are understandably wary of this technology, many such borrowers lack formal credit histories or traditional forms of collateral like land or a vehicle, making them difficult to serve with more traditional business models.

Energy Access' customers in Uganda are a good example. Overwhelmingly rural and dependent on irregular income from smallholder farming, they are among the most financially excluded and difficult-to-serve customer segments. The risk of serving these customers often deters lenders. Lockout technology essentially transforms assets that poor households are most likely to own — but whose low-value and rapid depreciation makes physical repossession uneconomical — into the collateral they need to unlock financing.

The impact of lockout technology on profitability also has implications for the ability of asset finance companies like Energy Access to improve portfolio quality and scale sustainably.

Unlike borrowers who take out cash loans, asset finance customers may be unlikely to return for further financing. This makes sense because once a customer owns an asset like a solar home system, they are not inclined to replace it until it breaks down or becomes obsolete. Traditional lenders like banks and microfinance institutions rely on repeat borrowers to drive profitability. By using lockout technology to allow borrowers with strong repayment histories to access new loans, companies can mitigate the risk that comes from growing only through new customers.

Implications for financial services providers outside the PAYGo solar sector

The encouraging results from the study should embolden lenders beyond the PAYGo solar space to expand access to credit using lockout technology.

Some providers are already experimenting with solutions. In Mexico, for example, PayJoy is using lockout technology to turn even inexpensive, used smartphones as collateral for cash loans. In Kenya, water pump financing company SunCulture has launched a new e-commerce platform called MITI, which allows customers to finance purchases of appliances, electronics and more by using their smartphones as collateral.

CGAP has argued for years that assets matter to poor people and are important for achieving the SDGs. The findings coming out of Uganda only serve to underscore the importance of asset financing. They demonstrate how simple assets like solar home systems can unlock access to financing for critical needs like education.