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How Fintechs Could Digitize Store Credit in the Arab World

For many people in developing countries, limited, irregular and sometimes uncertain income means that there are times when they don’t have enough money to buy basic goods like rice, oil or vegetables. People typically deal with these shortfalls by reducing spending, selling assets or borrowing money. Aside from family and friends, moneylenders and formal institutions, a common source of borrowing is the seller of the goods. CGAP’s research suggests that store credit is especially prevalent in the Arab world, and there may be an untapped opportunity for fintechs to digitize this form of lending Twitter logo in a way that adds value for merchants and customers.

How does merchant lending typically work in developing countries?

A spice and grocery merchant waits for customers in Sudan. Photo: Mohamed Faisal, 2018 CGAP Photo Contest
A spice and grocery merchant waits for customers in Sudan. Photo: Mohamed Faisal, 2018 CGAP Photo Contest

The key feature of store credit in the developing world is the source of both its power and its limitations: it is based on personal relationships. Merchants agree to sell things on credit to customers they know and trust, but they typically deny this service to others.

This makes social capital tremendously important for unbanked and underbanked people, who may lack access to formal credit but have relationships in the community that they can use as a form of collateral. However, having a good relationship with one merchant does not help much with another seller who doesn’t know you.

For merchants, store credit has potential to increase sales but is often a source of frustration. They too have cash-flow concerns and would not prefer to lend their scarce capital to customers. But they often feel obliged to do so because of social pressures and commercial considerations. In the competitive retail space, vendors often need to cultivate bonds with customers to retain their business over time.

How prevalent is merchant lending in the Arab world?

As shown in the chart below, people in the Arab world appear to rely on store credit almost twice as often as people in other regions Twitter logo. Borrowers tend to be older adults among the poorest 40 percent of the population, mostly working men with primary education or less. Despite stark differences in development levels between Gulf Cooperation Council (GCC) and non-GCC countries, borrowing seems to occur at similar rates across the board. This is surprising since GCC countries report account ownership levels much closer to the OECD average than the non-GCC countries. This means that people who own a credit card in Bahrein, Kuwait or Saudi Arabia are as likely as people who never had an account in Yemen or Iraq to enter a store, purchase goods and settle the bill later. This behavior might be more prevalent among migrant workers, who outnumber GCC nationals by far and often come from developing countries. In any case, people use store credit in the Arab World about three times more frequently than they use credit cards.

How could fintechs make store credit work better for customers and merchants?

While landscaping for fintechs in the region, we looked for companies that might have seized what looks like a market opportunity but found none. This is probably for a good reason. Digitizing merchant payments is an arguably difficult task and only comes once large-scale digital payments are happening, which is not yet the case in a number of countries. Besides, smaller merchants have little appetite to pay the typical 3-5 percent fee to process a digital transaction. Below a certain amount, the customer would actually need to pay for a digital transaction. At CGAP, we argue that if the customer is equally sensitive to price, which is often the case, acquirers who want to enroll merchants and drive transactions should offer free-of-charge digital transactions and have a revenue model based on developing value-added services (VAS), such as loyalty programs or digital store credit.

Below are three models that fintechs, merchant acquirers and other payments players could apply to digitize store credit, starting with the most basic model:

  1. Credit management. The simplest approach would be to facilitate existing behavior by recording store credit-based transactions on a mobile application, ideally but not necessarily linked to a mobile payment solution. This could work on both feature and smartphones, and it would benefit merchants and customers by enabling features such as automated SMS payment reminders, simple overviews of outstanding credit and digital records of transactions in case of dispute. The credit product itself would remain the same: merchants would offer credit only to customers they know and trust; the shop owner would still carry the risk; and the terms of that credit (duration, price and quantity) would continue to be determined by the shop owner. This approach would primarily aim to help merchants manage the credit they already give.
     
  2. Credit history. The next level up would be for financial services providers to keep track of customers’ repayment behavior and create a simple credit reference database that could help merchants assess the risk of lending to specific customers. This would expand customers’ access to store credit by making merchants more likely to give credit to people they don’t know personally, if the system indicates that they have a positive repayment history at other stores. This gives customers greater access to needed goods while increasing turnover for merchants. It would also equip merchants to deal with the social pressure around store credit, since they could point to the system while politely declining to extend credit to customers who have poor repayment behavior. This approach would primarily aim to capture the informal credit histories that most people have and create a formal record to be used within a closed system.
     
  3. Credit line. The final level would be developing a solution that combines customers’ store credit repayment histories with other types of data to enable financial institutions to underwrite store credit. Available data may include voice, SMS, mobile payment or savings. Such a solution could create a de facto credit limit for customers available at any merchant within a financial services provider’s network. There would be many winners in this approach, which would primarily aim to further formalize customers’ credit histories by opening them up to be used by third-party financial service providers.

    Customers would be able to move from an unpredictable credit limit with a few merchants to a digitally verifiable and predictable credit limit across an entire merchant network. They would know their limit and be able to buy on store credit regardless of whether they personally know the merchant.

    Merchants could make sales that might otherwise not have been possible and reduce the need to encumber their own capital. They would be able to mitigate the risk of extending store credit to some customers and the social — and thus commercial — cost of denying it to others.

    Financial institutions would be able to offer other financial products to customers who have a proven repayment history. This could substantially reduce the losses associated with loans to new customers that are common in current business models for mobile credit.

    Fintechs or payments providers offering the store credit services could increase their transaction volumes and revenues; obtain valuable payment and repayment data; and spur greater use of digital payments in the retail space. For providers trying to drive merchant payments, it could also be the type of value-added service that is needed for digital payments to become a truly compelling alternative to cash.

As digital payments ramp up in several countries, fintechs, merchant acquirers or other payments players interested in exploring the store credit opportunity have a number of models to consider. Notably, these could be implemented one after the other in a solution that grows progressively more sophisticated and compelling for providers, merchants and customers.

It is important to note that these solutions would need to be subject to the appropriate safeguards around data security and consumer protection, notably regarding informed consent and consumer control over the use of any data collected. If such considerations are managed well, this type of model could become one promising avenue for helping low-income people build formal financial records out of the informal behavior they are already engaging in.


To learn more about how fintechs can drive the digitization of merchant payments via value-added services like store credit, listen to this podcast featuring co-author of this blog post Peter Zetterli (also available on Apple Podcasts, Spotify, and other popular apps), and explore CGAP's collection of practical tools and resources. For more early insights from CGAP's fintech landscaping in the Arab world, see this blog post and this slide deck.

Resources

Podcast

What must providers do differently to make digital payments work better than cash for merchants and their customers? Peter Zetterli’s search for an answer led him to a surprising question: What if trying to be better than cash is the wrong approach?
Slide Deck

Merchant Payments: VAS Playbook

This playbook discusses the various potential Value Added Services that could increase uptake of mobile retail payments in Tanzania and similar emerging markets.
Blog

Where is fintech innovation happening in the Arab world? What types of solutions are emerging? CGAP shares preliminary results from our research on fintech in a region with roughly 140 million financially excluded adults.

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