It’s expensive to be poor. For instance, a family that doesn’t own a fridge – to keep perishables and cooked food for longer – must visit corner stores frequently and cook more often. Owning a fridge can save many hours every week, which can then be spent on something productive or at leisure. Because the poor can’t afford basic stuff – like a refrigerator or a gas cooker that can boost their productivity – the cost of their meals is likely far higher than a household that owns a fridge and a gas cooker. Inflation also hits the poor harder. Because they don’t own assets – the values of which usually rise in step with general price increases – they suffer more. Salaries rarely keep up  with inflation. Rent, energy and foodcosts, which take up the bulk of their budgets, also rise faster with inflation compared with the cost of services, which the rich spend most of their income on.

Liyanage Thilakaratne, a Civil Defence Force member, isn’t articulate about the economics around why it’s more expensive to be poor, but he easily explains why even a low-income earner with responsibilities would be more productive if they had a mobile phone. Unfortunately, his mobile phone was damaged beyond repair when it accidently fell in water. At a roadside store retailing mobile phones in Kalutara town, around 30km south of Colombo, he was able to obtain a new phone on credit. The credit wasn’t granted by the store, but by a startup that’s been giving small loans to borrowers who otherwise wouldn’t qualify to borrow from a financial institution.

“It’s a relief to small people,” he says about his ability to obtain credit, but also on how simple the process has been. All a qualifying borrower needs is a national ID card, an electricity bill and – if they have a permanent job – a pay slip. The day after submitting these to the shop, Thilakaratne was able to obtain the phone, having made only a partial payment. Rukula, after having reviewed Thilakaratne’s details submitted via Viber by the shop owner, granted the loan. Rukula pays the outlet the full price of the smartphone so the device is released to the buyer within a day. Thilakaratne also signed a loan agreement with Rukula, which the shop facilitated.

Credit to the poor is effective when it helps them become more productive and those gains then help repay the loan. This is not a new idea. I.M. Singer & Company, founded in 1851, provided credit to tens of thousands of women to purchase sewing machines, allowing them to pay for the purchase in monthly instalments with money earned from sewing or savings from not having tailoring costs in the household.

[pullquote]Businesses make various assumptions about the motivations of their customers. At Rukula, the main assumption is that people are good and even strangers will repay a loan[/pullquote]

Poor people are often self-employed or hold low-skilled irregular jobs that provide no proof of employment or a regular cash flow into a bank account. Banks and financial firms don’t lend to them because it’s difficult to reliably verify that they have the claimed income. Even those who lead financial institutions and believe in the goodness of people – even the poor – however, would think it foolish to lend based entirely on the belief that human beings are good and this makes them creditworthy.

Reeza Zarook has invested half a million dollars of his and his partner’s equity on Rukula, a business of which the success rests on his faith that people are inherently good. Of the assumptions businesses make about their customers, this is probably one that’s profoundly obvious, but utterly irrational.

Rukula’s (loosely translated from Sinhala to mean a ‘small support’) business model is based on lending to people whom the organized financial sector doesn’t consider creditworthy. They do this through a network of merchants from whom their customers purchase goods that they finance. However, these are not hire purchase transactions, where Rukula has product ownership until the last instalment is paid. A borrower takes ownership after signing the simple legal agreement and settling the first instalment. If a buyer refuses to pay back the loan – which has weekly or monthly instalment payments – there is little Rukula can practically do about it. Since it possesses a loan agreement, court action is possible, but for a maximum loan given of only Rs30,000, this makes no commercial sense. However, of the 2,500 loans that have been granted since inception, only a total of Rs15,000 has been defaulted so far, validating, Reeza’s goodness hypothesis.

Poor people frequently face liquidity crises and delayed instalments are common. In fact, only 10% of borrowers make all their payments on time. Nonperforming loans – classified as overdue for over a month – are in the high teens to mid-twenties, but all borrowers eventually pay. Rukula does not impose punitive late payment fees or default interest. However, the loan interest for first-time borrowers can touch 80% annually. The longest loan duration they grant is, however, six months.

The business was founded on this goodness premise, but he has had to tweak expectations because, despite being creditworthy, the poor are unlikely to pay loan instalments on time. “The issue isn’t dishonesty. They experience a financial crisis almost every other week: a tyre needs to be replaced in the three-wheeler, a parent is taken ill or a girl child attains puberty,” explains Zarook. “There was one guy who disappeared on us for three months and then turned up and apologized.” He had been in prison during that time, but undertook to voluntarily repay his rescheduled debt in a month.

Not only are users given ownership of the product upon signing the contract, but loan instalments thereafter almost solely rest on the user’s good nature. Rukula only accepts mobile cash transfers for instalments, which minimize their processing load and helps keep the organization lean.

People falling to the three lower socio economic classes [SEC C (lower), D and E segments] are in a cash economy; in NGO speak, they are financially excluded. They have income, but no access to bank loans or credit cards. They can only have access to credit via a micro finance loan or lease if they are an entrepreneur or three-wheeler owner.

To purchase an asset, they don’t have the full amount in cash; they either have to rely on the goodwill of the seller for staggered payments, or borrow from a loan shark (poli mudalali) who will charge a high interest rate – as does Rukula – but also resort to violence if the payment is overdue. “No one is talking to these people. They have an absolutely regular income and are probably more stable than an entrepreneur. We want to help these people, recognizing that they may not have proof of income.”

Borrowers are granted between Rs3,000 and Rs30,000 in credit, excluding charges and interest to purchase household goods like rice cookers, irons, mattresses, secondhand computers and mobile phones. Smartphones account for 80% of purchases at present, from over 100 Rukula-accredited merchants. No guarantors or collateral is required.

Rukula differs from a micro financing business (granting loans to small businesses and entrepreneurs), micro lending (which grants small loans to individuals) or payday lending (cash advance loans). Zarook says the firm has no equivalent in the rest of the world bar US-based Affirm.com, which offers similar terms to those aspiring for high-end durables, mostly millennials, charging an interest rate of 10-20% through a bank.

The bottom of the income pyramid, however, can’t be served on the same terms as other borrowers. Banks and other lenders have continued to ignore this vast majority of the population, even as they focus more on emerging consumers. Behemoths also typically move at sloth speed, an advantage for a startup, recognizing the value of ‘inclusive capitalism’.

Having identified the customer archetype early, Zarook spent six months planning and researching, and having his IT guy Adnan Issadeen build him the algorithm that lies at the heart of Rukula. This is the heart of the system about which Zarook is somewhat cagey. The algorithm utilizes 17 different attributes including age, gender, marital status, number of children, job type, electricity bill, payment records and English fluency – but counterintuitively, not income – to provide quite possibly the world’s first credit scoring system for the bottom of the pyramid sector.

The algorithm calculates what Zarook calls ‘stability’. Rukula operates on the leap of faith that the stability of the applicant and her family unit will drive whether she will finish making the payments. Zarook ignores income level, because this is almost impossible to verify since most of their customers are self-employed, like three-wheeler drivers, fishermen and domestic workers. The algorithm calculates a score between zero and 1,000, and a minimum score of 275 is required to be approved for a loan. The most stable applicant, according to Zarook, is a married woman over 30 years with young children below the age of 13. He reasons that she is the most creditworthy because she is unlikely to cut ties and disappear, because relocating school-going children is challenging. The stability represented by a family unit is, however, threatened if the children are older, as they can be put to work in case of a financial emergency; the legal working age in Sri Lanka is 14 years. The least stable applicants (most likely to default) are young men from the provinces working in Colombo and sharing a rented accommodation. They have few responsibilities, and can up and leave if they face any financial challenges.

Figuring they would have to be a retailer at this initial stage, the team purchased the products they knew would appeal to their customers. Early on, they considered what they wouldn’t lend for – “no watches, jewellery, perfumes or mobile phones, although that was soon put on the table,” Zarook explains. The then team of six went to homes of possible early adopters, competing with the diverse door-to-door sales people, and was quite often shooed away. Nevertheless, they managed to make close to 500 loans, and in testing the algorithm, even went against their core principles. People who scored less than 275 points in the creditworthiness evaluating algorithm were also granted loans.

Post trial era, Rukula works only via retailers, encouraging small and medium sized merchants to be part of the ecosystem. Although less sophisticated than large retailers, Rukula has found them to be “sharp” and willing to utilize technology, “but only if you are prepared to listen to their problems. Once they see that you are offering solutions to their problems, their enthusiasm is fantastic”.

Thushara Handunge is one of Rukula’s top-performing merchants. A mobile phone and accessories vendor based in Kalutara, he has been offering Rukula to his Super Cell Power customers close to a year now and says it accounts for about 40% of his mobile phone sales. His Merchant of the Year 2015 award from Rukula is displayed prominently in his somewhat small shop. A man of few words, his geniality makes up for his shyness. His enthusiasm is nevertheless obvious as he talks about the next phase of expanding sales – “group sales” — that is to offer Rukula to garment factory and other blue collar workers through their workplace at lower interest and no down payment with the support of a letter of employment.

Rukula wants to educate this population that a good credit score gets them cheaper credit and an opportunity, after two to three years of using Rukula, credit record in hand, to migrate to become a bank borrower.

Zarook, however, doesn’t see his business as fading into a natural death at some future point if borrowers graduate to mainstream financial services. “I think there are enough people to utilize this system before they move out.” In fact, Rukula is on course for “bigger things”, with plans to expand not only within Sri Lanka, to the Southern, Eastern and Northern provinces, but also beyond its shores. Zarook is eyeing Bangladesh, Pakistan, Indonesia and perhaps even India. He speaks of interest shown by a certain large player – a payday lender – in the US whose backend operations take place entirely in India.

It is crucial to raise a round of funding – Zarook is looking for $2-3 million in a first round of funding, and maybe one or two more partners to expand here and enter its first foreign market. He is not worried about the funding though, having kept diverse potential investors updated on the firm’s progress every quarter, and more importantly, now being in possession of a blueprint proven to work. He hopes to have landed in another country – intriguingly, either Indonesia because of its developed retail sector or Pakistan because of its lack of one – and with the help of  local partner, begun the six-month period of customizing the algorithm before a further six months of testing and extending their first loan within 18 months. The Shariah compliancy of the Rukula system will come into play as an essential element to break into either market considering their large Muslim populations.

[pullquote]“Monopolies are not good for any industry because there is no learning. There is space for other players. Good competition is good because you learn from each other.”
Reeza[/pullquote]

Zarook sees Rukula spinning off in more than the obvious linear direction, however: tackling donor syndrome in war and tsunami-ravaged areas by working with aid agencies, providing them with the mechanics and infrastructure to handle small loans for housing and amenities such as a solar panel; or offering health insurance in partnership with insurance companies to the low-income segment by allowing them to pay small weekly amounts (Rs100 per week would pay for a Rs5,200 annual policy), which can be deducted in full in case of a claim — not paying will only invalidate the policy and the company loses nothing if there is no claim.

There is also the option – like Wow.lk – of importing the most sought-after goods and, in essence, becoming a large retailer, but that is something that Zarook may consider only as a separate business, or perhaps a large retailer coming on board as an exclusive distributor to merchants who can then offer Rukula a commission for the privilege. The former is quite practicable even in the short-term, but Zarook fears the ensuing lack of focus will hurt Rukula’s core purpose.

If Rukula does succeed, and the signs point to it doing just that, it is quite likely that a host of other players, both large and small, will jump on the bandwagon in Sri Lanka and beyond. Zarook is not worried, not so much for the cost of building an algorithm, but because he considers competition healthy. “Monopolies are not good for any industry because there is no learning. There is space for other players. Competition is good because you learn from each other.”

The idea for Rukula took root in Zarook’s head during his stint at Anything.lk, a hybrid daily deals and online site founded by him. There he found that their heavy advertising and deep discounts were attracting a low-income consumer who aspired to own the rice cookers and TVs, but possessed neither a credit card nor the cash to pay for these appliances. They would keep asking to be allowed to purchase items on instalment plans, so much so that he suggested to the board of Anything.lk that they commence a financing scheme. The board, rightly – Zarook agrees – rejected the idea, it being far from their mandate as an ecommerce venture.

The differences between the institutions, however – excepting the startup “feel” – are nearly polar. If Anything.lk was bold and brash, Rukula is a lean canvas. Anything.lk’s speedy, chaotic adolescence to Rukula’s steady growth and maturity. Heavy advertising to no advertising. “Even if we triple our volumes, we’ll only have to hire one more senior person and four to five junior staffers,” Zarook assures. In September 2012, Zarook told Echelon of Anything.lk, “Honestly we don’t know past the next six months, things are changing so rapidly”, but with Rukula, they are riding a chartered course, albeit at somewhat of a faster pace than anticipated.

This is not to say that the Anything.lk experience was of no help with Rukula. Apart from a basic understanding of the customer archetype, Zarook has learnt from the “empire building syndrome” that can affect successful startups and opted for a flatter operational structure. Despite growing business volumes fourfold last year, Rukula has just 12 team members.