Responsible Finance Forum

Crowdfunding and Financial Inclusion

Ivo Jenik, Timothy Lyman and Alessandro Nava

EXECUTIVE SUMMARY

Crowdfunding has been touted as a financial innovation, a FinTech, the fastest growing financial industry, and the next big thing in finance. “Crowdfunding” typically describes a method of financing whereby small amounts of funds are raised from large numbers of individuals or legal entities to fund businesses, specific projects, individual consumption, or other needs. It involves bypassing traditional financial intermediaries 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.

A down side of crowdfunding is that it has the potential to be harmful to customers at the base of the pyramid. By design, a crowdfunding platform often matches consumers (funders) with a consumer (a fundraiser). This creates a peculiar regulatory challenge that requires a framework to be in place to protect funders and fundraisers. However, thus far, policy makers are predominantly focused on the risks faced by the supply side (investors, lenders, and other suppliers of funds), while neglecting the fact that the platform is often the only “professional” in the crowdfunding transaction, where both the investor and the fundraiser are equally vulnerable and inexperienced individuals or small businesses.

In this paper we argue that crowdfunding is a phenomenon that can play an important role in financial inclusion if an enabling and safe environment is in place. Examples of how crowdfunding may potentially benefit financially excluded and underserved 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 potential, 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 stakeholders, including independent researchers, policy makers, regulators, supervisors, standard-setting bodies (SSBs), and development professionals. This paper is written for a broad audience because the topic requires engagement by multiple stakeholders, including SSBs responsible for the regulatory and supervisory issues relevant to crowdfunding, other global bodies, and development agencies.

Section 1 of this paper defines crowdfunding, provides an overview of its evolution, and outlines a crowdfunding ecosystem; Section 2 explains in detail four basic categories of crowdfunding (donation, reward, debt, and equity), and lists their key benefits and risks; Section 3 focuses on modalities of the four categories of crowdfunding (hybrid models) with specific emphasis on the most recent trends; Section 4 highlights benefits of crowdfunding for broadening and deepening financial inclusion, while it also acknowledges risks and emphasizes the need for policy makers to keep up with the industry and intervene accordingly when necessary; in conclusion, Section 5 suggests possible directions for further research.

 

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