I watched this vid from FreeThink on Youtube. The funding model is pretty inspirational. Here is why I think it can work very well.
In financing, profit is made from gathering information. Firstly gathering information about new loan candidates and secondly through monitoring borrowers. This means you need to look out for two thing: Moral Hazard and Adverse Selection. As long as you can control for those two you make buckets. Adverse Selection has to do with the fact that people who are least likely to pay-off loans being the the biggest demanders of loans making the screening process difficult. Through the foundation and this franchise system where they screen the potential franchisees in the process they described with Dorcia (existing hard working employees) you are able to control for Adverse Selection. Moral Hazard is the risk associated with actions someone takes once you have given them the loan, like making risky business moves instead of what the business loan was intended for. This is controlled for through restrictive covenants (the items in a loan agreement that you’re not allowed to do or have to do while paying off a loan) and collateral (things you can lose if you don’t honour the conditions of the loan). The franchise acts as collateral and the more work she puts into it the more valuable it becomes, making her less likely to participate in actions that can be regarded as moral hazard. The key here is that the franchise setup and processes are fairly restrictive and enables the granter of the loan monitoring capacity.
If loan providers have the confidence that they are choosing the right people and that their debtors will keep paying, loans will be available. For poor communities the problem is usually collateral. Because information gathering and monitoring is so expensive, collateral is used. This is an instrument that decreases the need for spending too much on monitoring and enforcing restrictive covenants, because the desire to protect your collateral acts as a built-in enforcer. A funding model like this, the collateral is generated by the success of the franchise.
This kind of funding is what small local banks use to do efficiently. When the banker knew the people personally, or the town was small enough that they (singular) could phone around to make sure they were avoiding adverse selection, “riskier” loans could be made. In the modern era of big banks everyone is a profile and the information gathering and approvals are done through credit scores. This means people like Dorcia, and me, are less likely to get a bank loan. Or if we do, the interest payments are prohibitively high. Foundational funding like described in the video is an excellent way to mitigate this.
