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Crowdfunding struggles in emerging markets

Developing markets are lagging in crowdfunding, finds study at Cambridge Judge Business School. Regulation and corruption control are key factors in boosting crowdfunding volume.

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Based on the experience of mobile-phone banking, which rapidly took off in developing countries in Africa and Asia, many experts predicted that crowdfunding would catch on more quickly in emerging markets where many people lack access to traditional banks.

A new study at the Cambridge Judge Business School, University of Cambridge finds that’s simply not the case.

Instead, crowd sourcing has grown quickly in the developed world while lagging in developing countries – and the study finds that a country’s control of corruption and quality of regulation are significant factors in the volume of crowd financing being carried out.

The study – based on a database of more than 1,300 crowdsourcing platforms in 152 countries compiled by the Cambridge Centre for Alternative Finance – also found that the volume of crowd financing appears related to the level of trust individuals have for strangers, because such funding relies almost entirely on anonymous donors who have no social or other formal interactions with the recipients.

In addition, the study found that crowdsourcing volume declines when it is easier to do business in a country – suggesting that crowd financing volumes are tied directly to high costs or other obstacles in pursuing traditional channels. The data finds that the type of legal system, whether civil or common law, has little effect.

“While one might expect crowdfunding to take off rapidly in the developing world the way that mobile banking did, in fact the real crowdfunding growth is coming in developed countries,” says study author Raghavendra Rau, Sir Evelyn de Rothschild Professor of Finance at Cambridge Judge.

Raghavendra Rau

Raghavendra Rau

“Mobile phones helped in financial inclusion. When mobile phones penetrated markets that were poorly banked and where getting a landline was difficult, mobile banking soared. But we haven’t seen a parallel development in developing markets regarding crowdfunding.”

Professor Rau will present the paper later this week at the annual conference of the Centre for Alternative Finance (CCAF), where he is Research Director. The conference is being attended by leading experts on alternative finance from banking, business, government and academia.

The volume raised through crowd-financed platforms increased globally from around $500 million in 2011 to nearly $150 billion in 2015, a growth rate of over 200 per cent per annum, fuelled by advances in technology (thus the term “fintech”). The three largest crowd financing markets in 2015 were China ($103 billion), the US ($28 billion) and UK ($5 billion) – while far lower volume in some emerging markets included $40 million in India, $16 million in Kenya, $7 million in Nigeria and $4 million in Ghana.

The study – entitled “Law, trust, and the development of crowd financing” – is based on 1,362 crowdsourcing platforms in 2015; it follows detailed studies by CCAF on alternative finance trends and volumes in various regions around the world.

The study covers four distinct types of crowd finance business models – debt platforms for debt lending, equity platforms that allow firms to raise financing from investors, reward-based platforms where funders promise backing in exchange for non-monetary rewards, and donation platforms.

“This is the first paper that analyses the global determinants of crowd financing,” says Professor Rau. “Interestingly, the study finds that trust is the only factor that consistently seems to explain the volume on platforms that don’t have a financial motive, meaning reward-based and donation platforms.”

Globally, 98 per cent of crowd finance platforms are debt or equity platforms, and debt-based platforms are dominant with 96 per cent of crowd financing originating on those platforms. In emerging economies, however, the predominance of debt and equity platforms is less pronounced, at 82 per cent.

“The overall level of crowd financing volume is strongly positively related to the level of development of the market,” the study says. “However, controlling for the level of market development, there are three factors that significantly affect the volume of crowd financing within the country.”

Those three are: aspects of the legal system such as corruption control and regulation quality; the costs of using traditional financial institutions; and a set of user demographics including the level of access investors have to formal financial institutions and their ability to access the Internet.

“The study holds implications for both practitioners and policymakers in the fast-expanding sector of crowd financing,” says Professor Rau. “For platforms engaged in crowd financing, the study offers suggestions for country characteristics where crowdfunding is likely to succeed as an alternative to formal institutions, while from a policy perspective, the country level determinants of alternative finance volume help to make decisions on where regulations might help or hinder the growth of these markets.”