Does digital credit have a long-term sustainable value?

Digital lending apps have taken over Kenya’s most vulnerable, but who will ensure consumer protection?

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digital credit

Digital credit in Kenya, for a decade now, has been instrumental in granting formal credit to Kenyans, significantly boosting financial inclusion. It has provided individuals with the tools to manage their daily needs and working capital for small enterprises.

Although over half of the country’s population lives on less than USD3 a day and only a third of the adult population are banked, practically everyone has access to a phone with mobile money service. Data from Financial Sector Deepening (FSD) shows that over six million Kenyans have borrowed at least one digital loan via their mobile phones.

But the question that has lingered unanswered for long now is whether expanding access to digital credit has a long-term sustainable value. In the past decade, Kenya has become a fintech lab for companies creating financial solutions and products for underdeveloped financial markets like East Africa, thanks to the springboard provided by Kenya’s single most important innovation, MPESA.

Access to digital credit

The idea of financial inclusion is an evolution of microcredit and microfinance concepts; where poor people can pull themselves out of poverty by borrowing small amounts of money and investing it for profits. Before the widespread adoption of mobile phones, loans were typically provided by agents working with small groups of women.

This morphed into the idea of Chamas that was quickly adopted by women in informal and rural settlements and grew further to include even men and the youth. Peer pressure within the group was supposed to encourage repayment and a member defaulting on payments was chargeable to the whole group.

Then, in came fintech with mobile/digital lending apps. While banks such as NCBA and KCB Bank Group in partnership with mobile network operators were first to offer digital loans, several start-ups joined the bandwagon offering loans through apps. Tala, a Santa Monica based tech company operating in Kenya, for example, uses alternative data such as call logs, GPS, social network data, and contact lists obtained with permission of the user, to assess credit risk and tailor loan offers to their borrowers.

Data shows that Tala has disbursed over 5.6 million loans to borrowers, worth KSh.28 billion to over a million customers since its launch in March of 2014. Their mantra is they can reach the unbanked in Kenya because their software generates instant credit ratings from data obtained from prospective borrowers’ phones. Tala is part of the financial inclusion movement, a coalition of tech companies, banks, and non-governmental organisations trying to lift people out of poverty by offering them new ways to gain access to loans and other financial services.

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Risks associated with digital credit

With digital credit going mainstream in Kenya, borrowers are coming to terms with the fact that with financial inclusion comes financial risk. With dozens of apps offering short-term advances similar to shylock loans, more and more people are further sinking into debt.

Even the young people who once depended on family and friends are now being bombarded with ads for quick and easy loans. The loans carry with them exorbitant interest rates as the sector remains largely unregulated. For instance, Tala’s annulised interest stands at 180 percent.

Rogue money lenders hiding behind fancy apps are taking advantage of the regulatory vacuum to extort cash and personal data from users. A study done by FSD and the Bill and Melinda Gates Foundation found that dozens of mobile lending apps are operating with virtually no regulatory controls and set arbitrary fees for their loan facilities.

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There are more than 50 mobile loan services operating in Kenya and most of them operate without any formal supervision. Pressure has been mounting on the Central Bank of Kenya (CBK) to come out with a regulatory framework for this rapidly growing sub-sector. I do acknowledge that mobile loan apps do play a critical role in financial intermediation; thus for this very reason, the segment should be regulated to ensure the protection of both the borrower and lender.

A move by Members of Parliament to propose a law that will bring all mobile loan apps under the regulation of Central Bank of Kenya has received overwhelming support from players in the financial sector, even as digital lending apps are seen to slow down digital banking. The new rules could see mobile lenders disclose interest rates and transaction fees before giving loans.

Young people were found to be the most vulnerable to the lending platforms. The proposed law seeks to expand the role of CBK to license and regulate the micro-lenders, as well as prescribe capital requirements. CBK Governor Patrick Njoroge has in the past termed the mobile app lenders as “plain vanilla” loan sharks and called for their regulation.

High digital loan default rate

FSD data indicate that about 2.5 million Kenyans have defaulted on a digital loan with that number rising every day. About three million borrowers reported late loan repayments that attracted hefty penalties and nine percent of defaulters were reported to the credit reference bureau (CRB) as risky loanees.

Many other borrowers are trapped in a debt cycle, borrowing from one app to pay off another apps debt. Half of the borrowers spent their savings to repay loans, 20 percent of loanees reported reducing food purchases and 16 percent reported borrowing (mostly from family and friends) to offset their debts.

The non-performing loan (NPL) book for digital lender seems to be growing fast with the 2020 economic recession as a result of COVID-19 projected to increase the default rate. A few times a day for most Kenyans, their phones will buzz with a text message from a digital lender or a collection agent reminding/threatening them to pay their outstanding debts or risk being forwarded to Credit Reference Bureau.

Consumer protection

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Many investors in the financial inclusion community have supported digital credit because they see its potential to help unbanked or under-banked customers meet their short-term household or business liquidity needs. However, it is time for funders to rethink how they can support the development of digital credit markets.

There is a great need for Kenya to put greater emphasis on consumer protection. Kenya should thus develop tools to track over-indebtedness whose adverse effects hurt the well-being of families. Research shows nine per cent of the borrowers who are breadwinners in their families have been blacklisted by CRB. There is a need for more research on product innovation that promotes proper use of loans, thereby, ensuring digital borrowers are not stuck with low-value, short-term, expensive credit despite building positive credit histories.

At a market level, it will be important to strengthen credit reporting systems and require information reporting from all sources of credit, including digital lenders, to improve the accuracy of credit assessments.

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