but there is also a downside

By Victor Odundo Owuor (Senior Research Associate, One Earth Future Foundation, University of Colorado Boulder)

Over the past 10 years, mobile lending has increased in Kenya. Some estimates put the number of mobile lending platforms at 49. The sector is largely unregulated but includes major financial players. Banks such as Kenya Commercial Bank, Commercial Bank of Africa, Equity Bank and Coop Bank offer instant mobile loans.

These loan services have been made possible by the boom in the financial technology (fintech) industry.

Since the early 2000s, Kenya has been touted as a center of technological innovation from which new financial offerings have emerged. M-Pesa from the mobile phone company Safaricom is a well-known example. It is therefore not surprising that technology and unregulated lending have grown together so strongly in Kenya.

Digital lending services appear to bridge the gap for Kenyans who do not have formal bank accounts or whose incomes are not stable enough to borrow from formal financial institutions. These services have improved access to loans, but it is questionable whether the poor are being abused in the process.

Who borrows and why

A survey released earlier this year showed that formal financial inclusion – access to financial products and services – had increased from 27% of Kenya’s population in 2006 to 83%. M-Pesa was launched in 2007.

Mobile money services have benefited many people who otherwise would not have been banked. These include the poor, young people and women.

The next logical step was to make the loans available. The first mobile loans were issued in 2012 by Safaricom via M-Pesa.

In 2017, the financial inclusion organization Financial Sector Deepening Kenya reported that the majority of Kenyans have access to digital credit for business purposes such as investing and paying wages, and to meet the daily needs of households.

Some of their findings are illustrated in the figure below.

Unwrap the history of digital lending

The implications of these findings are twofold. Digital credit can help small businesses scale and manage their day-to-day cash flow. It can also help households deal with situations such as medical emergencies.

But, as the figure shows, 35% of borrowing is for consumption, including current household needs, airtime and personal or household goods. These are not the business or emergency needs envisioned by many in the investment world as the use of digital credit.

Only 37% of borrowers reported using digital credit for business and 7% used it for emergencies. Many in the development world thought that figure would be much higher.

Second, the speed and ease of access to credit through mobile apps has resulted in high indebtedness for many borrowers. In Kenya, at least one in five borrowers has difficulty repaying their loan. This is double the rate of non-performing commercial loans at conventional banks.

Despite their small size, mobile loans are often very expensive. Interest rates are high – some up to 43% – and borrowers are charged for late payments.

The business model of mobile lending is based on a constant invitation to borrow. Potential borrowers receive unsolicited text messages and phone calls encouraging them to borrow at extraordinary rates. Some platforms even contact the family and friends of borrowers when they request a refund.

It is not always clear to customers what to pay in fees and interest rates or what other terms they have agreed to. The model has been accused of causing borrowers to unknowingly cede important parts of their personal data to third parties and give up their dignity rights.

Concerns and remedies

There are concerns about how the economic model may make people even more vulnerable.

Most important is the debt culture that has become a by-product of mobile lending: borrowers fall into the trap of living on loans and accumulating bad debts.

So what can be done to improve the system so that everyone benefits?

First, even though digital loans are of low value, they can represent a significant portion of borrower income. This means that they will have a hard time paying them back. Overall, the use of high-cost short-term loans primarily for consumption, coupled with penalties for late payments and defaults, suggests that mobile lenders should take a more cautious approach to – view of the development of digital credit markets.

Second, some digital lenders are not regulated by the Central Bank of Kenya. In general, digital credit providers are not defined as financial institutions under current banking law, the Microfinance Act, or the Central Bank of Kenya Act.

Mobile lending platforms are offered by four main groups: prudential companies (such as banks, deposit-taking cooperatives and insurers), non-prudential entities, registered organizations and non-depository cooperatives as well as informal groups. such as savings circles, employers, traders and pawn shops.

Under current law, the Central Bank of Kenya only regulates the first two members of this list. They should therefore both be subject to the interest rate cap introduced in 2016. But some of the regulated financial institutions that also offer digital credit products did not comply with the interest rate cap, arguing that they charge a “facilitation fee”, and no interest on their digital credit products.

Third, and closely related to the point above, is the issue of disclosure. Borrowers often take out loans without fully understanding the terms and conditions. The information should include the key terms and all conditions of the loan products, such as loan costs, transaction fees on failed loans, bundled products (services offered and charged in tandem with the loan) and any other liability of the borrower.

Fourth, with 49 digital lending platforms, it is imperative that lenders are monitored and assessed for viability and compliance. Many mobile lending platforms are private (and some are owned by outsiders) and are not subject to public disclosure laws.

Finally, changes to the current digital credit system in all loan categories – prudential, non-prudential, registered and informal entities – are needed. An obvious system failure allows borrowers to seek funds from multiple platforms at the same time, creating a “borrow from Peter to pay Paul” scenario. At the same time, the country’s Credit Reference Bureau has been blamed for sometimes basing its reports on incomplete data.

Credit assessment systems need to be strengthened. They should obtain information from all sources of credit, including digital lenders, to improve the accuracy of credit scores. Efforts to improve the functioning of the system should determine whether digital credit screening models are robust enough and whether rules are needed to ensure that first-time borrowers are not unfairly listed. There could also be reckless loan rules or suitability requirements for digital lenders.

This article was first published by The conversation.


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