Professional Documents
Culture Documents
Group 1 Crowd Fin Inclusion
Group 1 Crowd Fin Inclusion
Crowdfunding and
Financial Inclusion
Ivo Jenik, Timothy Lyman, and Alessandro Nava
March 2017
TABLE OF CONTENTS
ACKNOWLEDGMENTS..................................................................................v
BIBLIOGRAPHY........................................................................................... 37
iii
ACKNOWLEDGMENTS
This paper was prepared by Ivo Jenik, financial sector specialist (CGAP), and
Alessandro Nava, senior associate (the Financial Conduct Authority [FCA]), with
guidance from Timothy Lyman, lead financial sector specialist (CGAP). Peer re-
view comments were provided by Kate Lauer, senior policy consultant (CGAP);
Margaret J. Miller, lead financial sector specialist (World Bank); and Marianna Nunan,
senior publishing officer (CGAP). Invaluable insights were provided by Fod Barnes,
senior advisor (FCA) and Jason Pope, technical specialist in the Strategy & Competi-
tion Division (FCA).
The authors especially thank FCA of the United Kingdom, which supported the work
on this working paper by seconding Alessandro Nava to CGAP for six months.
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Crowdfunding and Financial Inclusion
B2P Business-to-Person
B2B Business-to-Business
EU European Union
P2P Person-to-Person/Peer-to-Peer
P2B Person-to-Business
vi
EXECUTIVE SUMMARY
Crowdfunding has been touted as a financial innovation, a FinTech, the fastest grow-
ing financial industry, and the next big thing in finance. “Crowdfunding” typically de-
scribes a method of financing whereby small amounts of funds are raised from large
numbers of individuals or legal entities to fund businesses, specific projects, individ-
ual consumption, or other needs. It involves bypassing traditional financial interme-
diaries and using online web-based platforms to connect users of funds with retail
funders. Definitions of crowdfunding vary, but they often include the following key
components: (i) raising funds in small amounts, (ii) from many to many, (iii) using
digital technology.
The idea of matching people who need money with the people who have money to
invest is not new; what is new is the way this concept of intermediation is facilitated
(and made easier) by technology. Crowdfunding has the potential to transform retail
financial services as the use of technology, increasing connectivity through mobile
phones and other devices, the legal and regulatory framework, and constantly
changing economic conditions allow new and innovative firms to compete with
incumbents. This competition could foster economic growth and entrepreneurship,
especially in countries with less developed financial systems.
In this paper we argue that crowdfunding is a phenomenon that can play an im-
portant role in financial inclusion if an enabling and safe environment is in place.
Examples of how crowdfunding may potentially benefit financially excluded and un-
derserved people include improving access to finance to unserved and underserved
borrowers; creating cheaper, community-based insurance products; and facilitating
access to digital investments by people who currently have limited or no options to
get financial returns on their savings. There are many stories illustrating this po-
tential, such as the one of Lydiah from Kenya, who has been using crowdfunding
to finance her small electrical supply shop and her side business of serving M-Pesa
customers.1 Moreover, crowdfunding first emerged in developed countries, but took
off fairly recently, with some of the emerging markets and developing economies
leading the peloton.
This paper aims to map the crowdfunding phenomenon globally, explain its main
characteristics and modalities within the framework of financial inclusion, and
highlight the areas that require further attention of policy makers. It is based on
a combination of secondary, desk-based research and interviews with stakehold-
ers, including independent researchers, policy makers, regulators, supervisors,
1 See https://www.zidisha.org/loan/zidisha-loan-to-boost-my-business-capital-1.
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Banking and Payments. The rapid spread of digital innovations, such as Internet
banking, mobile payments, and mobile wallets, is changing traditional banking for
consumers and businesses. New start-ups promise to deliver traditional services
in a cheaper, faster, and more transparent way than traditional banks. Providers
include, for instance, Atom Bank, Mondo, TransferWise, and GoCardless.
RegTech. This term refers to the use of technology to address regulatory and
compliance challenges efficiently and effectively (see, e.g., IOSCO 2016).
RegTech is changing how companies perform identity verification (biometrics) and
know-your-customer policy, protect their clients’ data (cryptography), and settle
transactions (distributed ledgers). To keep pace with the industry, supervisors are
now more intensely exploring ways to improve their capacity by implementing
new technology solutions. Providers include, for instance, Suade, Trulioo, KYC
Exchange Net, and Vizor.
Note: The examples of providers listed in this box have been selected solely to illustrate practical use of FinTech.
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2 The development of collaborative finance was made possible through digital networking and communication infrastruc-
tures that provided a platform for instantaneous communication and cooperation. This new form of finance is character-
ized by highly personalized loan transactions, providing much more flexibility for borrowers in terms of loan purpose,
interest rates, collateral requirements, maturity periods, and debt rescheduling. See, e.g., https://en.wikipedia.org/wiki/
Collaborative_finance.
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3 “Big Data” has been defined in various ways. Many tend to highlight the following definitional features: (i) high-volume data,
(ii) produced, collected, and processed with high speed, (iii) variety information assets, and (iv) technology-based process-
ing of data in a meaningful way to enhance insights and decision-making. Examples of Big Data being used in a financial
services context include Ant Financial (the Alibaba financial services arm), M-Shwari, Cignifi, and Lenddo. See, e.g., Gartner
IT Glossary (http://www.gartner.com/it-glossary/big-data).
4 “This development [in the crowdfunding industry] leads to questions over the extent to which loan-based crowdfunding
platforms allow for regulatory arbitrage with banking business, without being subject to the same consumer protection
requirements, or whether the way they describe their business models or the products on offer could be misleading to
consumers” (FCA 2016, p. 14).
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worldwide (see, e.g., Massolution 2015 supply. The demand side consists of peo-
and Zhang et al. 2016a). Regardless of ple and entities seeking funds. Depend-
recent signs of a slowdown (European ing on the specific model, we talk about
Commission 2016a), the crowdfund- beneficiaries (donations, reward-based
ing industry keeps growing fast—the crowdfunding), borrowers (debt), or is-
fastest in Asia, with 210 percent year- suers (equity), who can range from in-
on-year growth (Massolution 2015), dividuals to micro, small, and medium
driven by countries such as China enterprises (MSMEs), nongovernmental
(estimated between US$60 billion and organizations (NGOs), nonprofit entities
US$100 billion), India (US$27.8 million), (e.g., charities), start-ups, and financial
the Philippines (US$26.9 million), and businesses. The supply side consists of
Nepal (US$25.5 million) (Allied Crowds donors (donation), backers (reward),
2016). In Africa, crowdfunding plat- lenders (debt), and investors (debt, eq-
forms raised US$37.2 million in 2015 in uity). Funders range from private indi-
Kenya, Rwanda, Tanzania, and Uganda viduals, to angel investors and venture
(Allied Crowds 2016b). Figure 1 shows capitalists, businesses, and large finan-
a global picture that combines numbers cial institutions. In this paper we refer
from various reports. to the supply side as “funders” and to
the demand side as “fundraisers,” unless
1.2. Ecosystem and Categorization otherwise specified. Besides the plat-
form, the fundraisers, and the “crowd”
A crowdfunding ecosystem can be com- of funders, other entities are neces-
plex and may vary substantially from sary for the crowdfunding ecosystem
model to model. The central point of to work (enablers), including payment
every crowdfunding ecosystem is a systems and payment service provid-
platform—a technologically enabled ers, technology infrastructure, and data
solution used to match demand with analytics.
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5 Most risks and benefits in donation-based crowdfunding apply to other categories of crowdfunding as well.
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civil code, (ii) tax law, (iii) a law regu- campaign, entrepreneurs raise aware-
lating charities and public fundraising, ness about new projects and products,
(iv) consumer protection law, (v) data and receive feedback from potential
protection law, and (vi) criminal law customers. For instance, a start-up may
(fraud, cyber-attack). test interest in an innovative idea6 or an
established company may test potential
uptake of a new product.7
2.2. Reward-Based Crowdfunding
The Asia-Pacific region is leading in
2.2.1. Model Description and Use reward-based crowdfunding numbers.
Reward-based crowdfunding allows Excluding China, the total reward-based
funders (donors) to contribute to crowdfunding volume within the
campaigns in exchange for a nonfinan- Asia-Pacific region in 2015 was more
cial reward. Rewards often take the form than US$81 million, almost double the
of tokens of appreciation (artist’s auto- US$41.7 million raised in 2014. In China,
graph, mentioning the donor’s name in the earliest reward crowdfunding plat-
the credits, T-shirt) or the prepurchas- forms were start-ups, but a number of
ing of a product or service (the actual China’s largest e-commerce companies
invention) according to the contributed have launched reward-based crowdfund-
amount. Reward-based crowdfunding ing platforms since 2013. It is estimated
shares many commonalities with dona- that it raised US$829.52 million in 2015
tion-based crowdfunding, and sometimes (Zhang et al. 2016a). In the Americas,
is included in the same category (Vargas, the market volume of US$658.37 million
Dasari, and Vargas 2014). In addition to was generated in 2015, up 22 percent
the key motivations described for dona- from 2014’s US$513.96 million. This
tion-based crowdfunding, donors expect model accounted for 2 percent of the
a more tangible outcome of their invest- total market in 2015. North America ac-
ment. Revenues for a platform come counted for US$645.70 million (Wardrop
from the fees deduced from each contri- et al. 2016). Reward-based crowd fund-
bution (see Box 4). There are two main ing is the second largest sector within
common subcategories of reward-based the European online alternative finance
crowdfunding: (i) all-or-nothing and (ii) market (excluding the United Kingdom)
keep-what-you-raise. with €120.33 million (approximately
US$130 million) raised in 2014 (com-
This category of crowdfunding is pared with €63.18 million in 2013).
primarily used to fund art (movies, In the United Kingdom, £42 million
music) and for the development of (approximately US$55 million) was fa-
new products and innovations. In ad- cilitated through reward-based crowd-
dition to financing, crowdfunding can funding platforms in 2015 (Wardrop
serve marketing purposes: through the et al. 2015).
“Fees are only charged on successfully funded projects. We charge 5%, in addition
to any fees from our payments partners” (www.kickstarter.com/terms-of-use?ref=
footer/).
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8 Similar findings are echoed by another study of artistic projects, where the investor decisions were compared to “expert”
evaluators of art quality. The authors found no differences between projects selected by the crowd and those selected with
involvement of experts. See Mollick (2015), pp. 1533–53.
9 www.kickstarter.com/fulfillment
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10 The term “wisdom of the crowd” has been used in a study focused on accuracy of the collective decision-making process.
See Surowiecki (2004).
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11 www.kiva.org/about/where-kiva-works
12 www.zidisha.org/why-zidisha
13 For instance in the United Kingdom there is a product called “mini-bonds.” Similar to traditional bonds, mini-bonds allow
issuing companies to crowdfund unsecured debt at competitive rates; however, the regulatory requirements are much less
stringent for mini-bonds than for regular bonds (see, e.g., https://www.syndicateroom.com/crowd-investing/mini-bonds).
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Plaorm Plaorm
Account
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offline through direct channels and offers more tangible benefits to funders
in-person sales techniques, including (investors):
the process of creditworthiness assess-
ment. Once the loan was funded and
■■ Access to a new asset class. Kirby
disbursed, the platform collected repay- and Worner (2014, p. 21) argue
ments in person on behalf of funders that “[p]eer-to-peer lending plat-
(Aveni et al. 2015). forms have in effect provided in-
vestors with a brand new asset in
Debt dominates crowdfunding markets the form of un-collateralised debt.”
around the world, with the Asia-Pacific They further argue that this may al-
region ranking at the top. In China, P2P low for better portfolio diversifica-
lending is the largest category of Inter- tion, ultimately leading to reduced
net finance, with reported market vol- systemic risk as funders invest
ume of US$52.44 billion in 2015 (Zhang small amounts in diversified assets
et al. 2016a) compared to US$36.16 instead of over-relying on a single
billion in North America (Wardrop et asset. Whether or not crowdfunded
al. 2016). In Latin America and the Ca- loans would be treated as a new as-
ribbean, between 2013 and 2015, P2P set class ultimately depends on the
platforms raised US$19.43 million in relevant regulatory regime. Regard-
2015 (Wardrop et al. 2016). In Eu- less, debt crowdfunding widens
rope, debt crowdfunding is estimated access to an investment class not
to have raised €3.21 billion (approxi- easily available to retail investors in
mately US$3.60 billion) in 2015 (Euro- the past. Putting aside institutional
pean Commission 2016a). P2P lending investors and professional lenders,
reached £909 million (approximately some of the funders lending money
US$1.2 billion) in the United Kingdom over the platform to individuals,
alone in 2015, compared with £547 mil- MSMEs did not previously have
lion (approximately US$700 million) in this option and would instead place
2014 (Zhang et al. 2016b). their savings in savings accounts, in
collective investment schemes, or
2.3.2. Benefits and Risks the like (although the risk inherent
in such savings/investment prod-
A. Benefits ucts is likely to be different from
that of investment in crowdfunded
The major benefits of debt crowdfund- assets).
ing are convenience, efficiencies, and
potential to improve access to credit ■■ Higher financial return. Crowd-
by excluded and underserved groups. funding offers a thigher return for
Application for a loan typically takes funders than savings (corresponding
only a couple of minutes, can be done to a higher risk). This is particular-
from a distant location, does not require ly important in the current low-in-
credit history, and may concern per- terest environment where many
sonal loans and business-development investors and savers search for yield.
loans. The same convenience benefits In particular, crowdfunding can help
funders. In addition, debt crowdfunding satisfy a demand from funders who
preserves the advantages described for want the higher average return and
the previous two categories of crowd- are prepared to accept the high
funding (donation and reward-based), volatility of that return and/or low-
including community participation and er levels of consumer protection
philanthropy, formalization of contracts, and funders who are willing to com-
and wisdom of the crowd. In addition, it promise on services traditionally
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14 Some platforms require or allow borrowers to provide collateral (see, e.g., www.crowdo.com, where borrowers often offer
jewelry or gold as collateral).
15 Debt crowdfunding has grown mainly during a period of relatively stable economic recovery, but the platforms that experi-
enced the global financial crisis saw greater loan losses. For instance, Zopa claims to have one of the best loan performances
among all P2P lenders with post-crisis (since 2010) bad debt at only 0.25 percent (see www.zopa.com/lending/risk-
management); however, Zopa’s default rate in 2008 was 4.33 percent (see www.zopa.com/lending/risk-data). For Prosper,
currently the second biggest P2P platform in the United States, the 2008–2010 loan portfolio in 1–14 day arrears was
nearly 30 percent, according to Lendstats (see lendstats.com/wordpress/?p=218).
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17 http://p2pfa.info/wp-content/uploads/2015/09/Operating-Principals-vfinal.pdf
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18 Exceptions include Indonesia, Korea, Malaysia, and Taiwan, which have passed a special tailored regime to allow equity
crowdfunding, while Indonesia, Thailand, and Vietnam are working toward it.
19 See, e.g., Symbid investment, which is done through a cooperative vehicle established in the Netherlands (http://symbid
.com/pages/model).
20 https://angel.co/syndicates
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Plaorm
Funds
Plaorm
21 For instance, OurCrowd has a due diligence team that vets deals before they are presented to investors and is an active
investor in the deal; it retains preemptive rights, thus providing the companies and investors a framework to raise and
invest additional funds in future rounds and follow-ons (www.ourcrowd.com/how_it_works/an_introduction).
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Crowdfunding and Financial Inclusion
and instead, funders take the hit enough evidence yet regarding whether
alongside the fundraiser. and how likely these scenarios are. Un-
til they exit, funders are unlikely to re-
■■ Global reach. Equity crowdfunding ceive any payment because early-stage
allows access to funders all around and growth-focused businesses rarely
the world. This is particularly rele- pay dividends. Should a funder realize
vant in countries with underdevel- a profit, complex tax obligations may be
oped capital markets. triggered as a result of the international
■■ Improved investment attractive nature of crowdfunding.
ness. A successful campaign may
Issues surrounding the gap in protection
act as a signal to established in-
of fundraisers in debt crowdfunding are
vestors (including venture capital-
even more relevant in equity crowd-
ists), showing potential consumer
funding. Equity crowdfunding is mar-
demand, thus attracting additional
keted to fundraisers as a simpler and
sources of funding.
cheaper way to fund business develop-
Equity crowdfunding is highly risky ment (as compared to more traditional
and illiquid. A recent study shows that sources of capital). Fundraisers may
of the 367 businesses that attracted in- then underestimate actual campaign
vestment through the United Kingdom’s costs, compliance costs (e.g., of regular
five major equity crowdfunding plat- reporting), investor management costs
forms between 2011 and 2013, only (e.g., communication with hundreds and
22 percent have gone on to raise funds thousands of funders), and opportunity
at a higher valuation or have realized a costs in terms of foregone expertise be-
return for their funders through a sale cause venture capitalists often bring
or other form of exit (Altfi 2015). This is industry knowledge and networking
most likely because early-stage ventures opportunities. Traditional equity inves-
and SMEs are inherently risky,22 and the tors may even be able to offer capital at
risk is further exacerbated by the lack of a lower price than equity crowdfunding
incentives for individual funders to con- because of their capacity to assess and
duct due diligence given typically small price risks better.
equity stakes.
The regulatory requirements, with
Investments made through crowdfund- which fundraisers need to comply,
ing are likely to be subject to dilution may expose fundraisers to unwanted
when the business raises additional public scrutiny. Other sources of fund-
capital at a later date and issues new ing, including nonequity private debt,
shares to the new investors. Illiquidi- home-equity loans, and loans from
ty poses another major risk to crowd- friends and family members, allow fund-
funding and available options for exit raisers to keep their business know-how
are limited. In the absence of a sec- and innovation hidden from the gener-
ondary market, funders may either al public, while crowdfunding requires
sell their position over the counter to a higher level of disclosure. In addition
any interested party or wait until the to the risk of disclosing too much infor-
company is acquired by a strategic in- mation to competitors, this may have
vestor, merges with another company, negative repercussions on intellectual
or issues an IPO. However, there is not property protection (patentability).
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23 A World Bank study of the Kenyan securities regulatory environment determined that various pieces of secu-
rities legislation allow for crowdfunding, but they are subject to interpretation, making it hard for businesses
to set up a crowdfunding platform (Raymond 2014).
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24 www.energyfunders.com
25 See, e.g., Foley (2016).
26 See, e.g., Gönülal (2013).
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27 For instance, Australian Westpac has acquired a stake in SocietyOne, Australia’s leading P2P lending platform. Barclays
Africa has acquired a stake in RainFin, the leading South African P2P lending platform. See, e.g., Renton (2014).
22
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D. Lack of Awareness and Trust GeoPoll, GES, and the U.S. State Depart-
ment African Entrepreneurship Survey
Finally, another challenge for crowd- 2015 found that 13 percent of respondents
funding in developing markets is a lack mentioned crowdfunding as a source of
of general awareness and trust. Because online funding (Mobile Accord 2015).
crowdfunding is a recent phenomenon, in
many markets there is little overall aware- Table 2 summarizes the key benefits of
ness among potential users (funders crowdfunding, while highlighting im-
and fundraisers) of this innovation. This portant measures to put in place to ad-
is changing, however. For example, the dress key challenges.
• Funder education
• Liquidity enhancement
• Restrictions—profile, stakes
• Guarantee mechanisms/diversifica-
tion/portfolio management rules
• Access to a new class of assets [Note: Equity crowdfunding does not
Equity
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■■ The adequacy of the legal and regula- ■■ The risk or regulatory arbitrage,
tory framework to address the risks particularly in the light of the re-
faced by fundraisers and funders. cent trend of institutionalization and
hybridization.
■■ Minimum regulatory standards for
the industry and supervisory guid- ■■ The level of customer awareness
ance for the responsible supervisory concerning the risks and benefits of
authorities. crowdfunding.
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Legend:
1. The campaign objective
2. The certification indicating that the fundraiser has been subject to due diligence by
the platform
3. Indication of the threshold, amount raised and time remaining
4. Payment methods available to donors
5. Information about the campaign, fundraiser and other disclosure
6. Indication of the threshold, amount raised and time remaining
Source: Kiva
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2. Reward-Based Crowdfunding
Legend:
1. Three steps to set up a campaign
2. Key features of the campaign
3. Beneficiary’s profile
4. Information about the project
Source: IdeaMe
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3. Debt Crowdfunding
Legend:
1. The funder’s main dashboard
2. The list of loan asks
3. The borrowers’ credit rating provided by the platform
4. Detail of the loan ask, including the downloadable fact sheet with more details
about the borrower
Source: Crowdo
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4. Equity Crowdfunding
Legend:
1. The summary offer
2. The detailed information about the offer
3. Disclosure
Source: Seedrs
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Cheetah Fund—was a €400,000 fund that partnered with the 1 percent Club
Netherlands (a crowdfunding platform) aimed at supporting African start-ups to
kick-start or boost their projects. If borrowers managed to crowdfund at least
30 percent of their target amount via 1 percent Club within 30 days, the Cheetah
Fund then granted them the remaining amount.
Ketto—an Indian platform, where each borrower is assigned a manager who helps
the borrower raise money. Moreover, to facilitate investor donation, it partners
with a courier service to offer cash pick-up, tapping into India’s cash culture.
MYC4—a platform that allows investors to invest in SMEs in Africa. Once the
project is approved by MYC4’s local partners, prospective investors participate
in an online auction where they bid the amount they wish to lend and at what
interest rate. The investor offering the lowest interest rate ends up lending money
to the business when the auction is over.
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Crowdfunding and Financial Inclusion
United Prosperity—a nonprofit platform operating in Sri Lanka that partners with
MFIs to offer funding solutions and reaches more unserved clients. The 0 percent
interest capital raised on the platform is used by borrowers as cash collateral at
local banks, and is not an actual loan, thus incentivizing banks to make loans to
MFIs. Between 2009 and 2013, the platform has facilitated more than US$280,000
in loans to 1,300 families (Aveni 2015).
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