Credit rating, audits, and the African environment 3/3
Potential solutions
Despite their limitations, credit rating agencies and auditing firms play an important role in Western economies. They evaluate organisations in order to establish their credit-worthiness or their financial credibility. Due to their importance in the West, they have been imposed on the African continent’s own business world.
As we saw in ‘Credit rating, audits, and the African environment’ parts 1 and 2, Western methods of credit rating and auditing are not suited to Africa. African economies are not altogether like those in the West. Business owners often see little need to follow international or even local accounting standards, particularly in the informal sector.
Africa is a hive of innovation. New alternatives to credit rating and auditing have arisen. The possibilities presented by blockchain technology and FiftyFor’s digital business community show that, in the future, audits and credit ratings might not be necessary to businesses in Sub-Saharan Africa.
Gauging trust with FiftyFor
Credit ratings are a tool designed to help banks understand how confidently they can lend money to businesses. They also help investors and other businesses in their decisions about who to work with: credit ratings act as a kind of measure of trust.
However, as we saw in [Part 1], the methods used by credit rating agencies, as well as their scope, are unsuited to the African environment. The continent’s informal sector accounts for 72% of employment and 41% of GDP south of the Sahara. Businesses in the informal sector are not bound by formal accounting standards and are often unable to provide the necessary financial documents required by credit rating agencies. Furthermore, young companies (which are proving to be central to the development of countries like Nigeria) do not have the experience to prove their creditworthiness. On a global scale, credit rating agencies are vulnerable to a conflict of interest.
FiftyFor is a new way of measuring trustworthiness, and by extension creditworthiness. Businesses may join the platform and provide ratings of other businesses’ governance, finances, operations and sustainability based on previous experiences.
Such a methodology assures that FiftyFor accounts for Africa’s thriving informal economy while simultaneously encouraging businesses (both informal and formal) to work to high standards. And, since ratings are accumulated in real-time, a young company can quickly acquire a reliable rating. Vigorously tested algorithms verify the ratings by analysing their collective reliability.
FiftyFor promises to encourage the growth of a business community or network. A network which maintains accountability, meaning that trust can extend beyond a founder’s circle of friends, family and extensions thereof. To avoid a conflict of interest, FiftyFor’s services are paid for by the businesses wishing to access the data (be they foreign investors or local businesses searching for potential suppliers).
Alec Fokapu, the founder and CEO of FiftyFor, explains how the platform is designed to suit African economies: “In Africa, trust is spread through word of mouth. People confide in others because they are reassured by those close to them that they have nothing to worry about. We took this model, and we digitised it.”
This new method of building and measuring trust should unlock Africa’s business potential, promoting collaboration between businesses and encouraging banks to provide credit.
Introducing: the blockchain
Audits too can be used as a measure of trust. A clean financial audit is an indicator of good accounting practices and, by extension, a stand-up approach to business transactions. FiftyFor’s platform can help businesses to show that they do business ‘the right way’.
There is, nonetheless, a necessity for rigorous analyses of financial records. Otherwise, businesses may still be able to hide dodgy deals or creative accounting too easily. Blockchain technology may be a solution — a new, more effective style of auditing for Africa.
Fundamentally, the blockchain is a method of storing information securely over time. A ‘block’ refers to a record of events that have occurred since the previous block (a bit like a chapter in a book or a few lines of a financial statement). The interval between blocks is usually a matter of minutes or seconds. What is unique and important about the blockchain is that each block is linked to previous blocks by something called a ‘hash’. This is simply a kind of permanent link that cannot be changed. Each block is therefore necessarily linked to all previous blocks.
The result is that once a block is entered into the blockchain, it cannot be altered without altering the whole history of blocks. Furthermore, it is a community of users that police the blockchain, meaning no individual or group may alter its story to their own benefit. For a block’s information to be changed, a majority of the community must approve the change. The majority must also approve the entry of each block — data cannot be submitted without a consensus agreeing that it is true.
The use of blockchains for land registries illustrates the idea. Particularly in emerging economies, centralised land registries are subject to corruption. Powerful individuals have been known to alter registries for political or financial gain, putting land or assets in the wrong people’s hands. In Georgia, blockchain technology is being used to replace centralised land registries.
Every transaction of land assets is recorded in the blockchain in real time. If records show that transactions really did take place, then there is a consensus to add the transaction permanently to the blockchain. The transaction is now virtually indisputable and the blockchain shows who really owns the land. As the Redherring explains, “Since the blockchain entries will be immutable, it will not be possible for any official or individual to change records in favor of any party.”
The blockchain removes the need to trust or rely on a central power such as a government land registrar or financial auditor.
Blockchain for auditing
But how, exactly, could blockchain technology affect the world of financial audits? Just like with land registries, business transactions could be recorded on the blockchain.
Fintechnews explains how this might be conducted: “All that would be required at the time of the transaction would be for the two trading parties to compare accounting entries while maintaining data privacy. To ensure the data can’t be changed, digital signatures would be used.” Digital signatures, or some other secure record of a transaction, could act as the consensus required to write a transaction into the blockchain.
Even Deloitte, one of the world’s largest auditing firms, recognises the potential power of blockchains in this field. Transactions recorded in a blockchain can create “an inter-locking system of enduring accounting records. Since all entries are distributed and cryptographically sealed, falsifying or destroying them to conceal activity is practically impossible.”
Conceivably, financial records could then be nothing more than automatically-produced stories told by the blockchain’s data. Its record of a single business’s transactions over a year could be compiled to produce one document, i.e. a financial report.
This presents huge advantages for Africa. In a continent where auditors are not always held sufficiently to account, where accounting standards vary massively, and where the informal sector is unmotivated to produce official and conformative financial statements, blockchains could entirely replace the practice of auditing.
Businesses in the informal sector would not need to labour over the IFRS for SMEs. Simple agreements on transactions could see their financial records automatically managed, visible to the public and the business community. No trust would need to be placed in the hands of auditors, but rather the public could monitor transactions itself.
The hack of The DAO (a blockchain-based crowdfunding platform) demonstrates that blockchain technology is not completely immune to criticism. Measures still need to be made to assure that further uses of blockchains are more secure. However, this technology is still only young and being developed. It’s potential to help in the financial sector, particularly in Sub-Saharan Africa’s emerging economies, is unquestionable.
Both FiftyFor and the blockchain are network-based solutions. By placing responsibility and accountability in the hands of a community, they democratise the processes of financial rating and validation and facilitate trust. LinkedIn’s network-based alternative outdid Monster in the online recruitment market. FiftyFor and the blockchain could do the same to credit rating agencies and auditing firms.
Originally published at FiftyFor.
