November 13th, 2019

The first article in a blog series examining the Kenyan credit market by FSD Kenya drew an analogy between the recent forest fires in the Amazon Jungle and the explosion of digital credit in Kenya. Just like putting out the forest fires is not equivalent to solving the problem of climate change, there are wider issues in the Kenyan credit market beyond digital credit. Yet, the question remains why digital credit has witnessed an explosion in ‘growth’ unlike other segments of Kenya’s financial sector and whether it is additive or extractive.

To answer these questions, it is useful to start by going back to the basics and examining the role of finance. For households and enterprises, it is managing day-to-day, dealing with risk and investing. Budgeting is a familiar task to households while enterprises grapple with working capital needs daily. An unexpected event can quickly impact the financial circumstances of a household or an enterprise. Households invest, for instance, to build human capital through education while a food vendor can invest in a larger outlet to serve more customers. Often, there is limited usage of the formal financial instruments developed to meet these needs.  FinAccess 2019 shows that most households (50.2%) rely on social networks rather than insurance (2%) to deal with shocks. Social networks are the primary means of meeting day-to-day needs (33.1%) compared to formal instruments (13.3%). The  financial diaries study offers the best insight on how low-income households manage their finances, revealing that poor households used a large number of informal financial devices. The median number of devices was 14, inferring that no single tool is able to meet all households’ needs.

Credit, on the other hand, is the lubricant of this system, allowing borrowers to tackle volatility in income and consumption, cope with risk and facilitate investments even in the absence of a formal savings, insurance or investments product. Often, the financial solutions used to deal with shocks and meet day-to-day needs involve an element of informal borrowing. Credit granted by shopkeepers remains the highest source of credit to households in Kenya (29.7%). It is in the payments area that households are actively using formal instruments, with 79.2% of households using mobile money services daily.

Developments in mobile money have contributed to the proliferation of digital credit, with lenders seeking to exploit the digital footprints of users to offer loans that are derived and repaid digitally typically over a mobile phone. All these features appeal to borrowers. All FinAccess respondents who have borrowed digitally state ease of access as the sole reason why they borrow digitally. Further evidence suggests that there is demand for this form of credit. Over six million Kenyans have borrowed at least one digital loan to meet day-to-day household needs. At the same time, FinAccess show that the usage of digital loan apps has grown from 0.6% in 2016 to 8.3% in 2019.

While there are many bright spots that impact on livelihoods and small enterprises, there has been increased attention to wider consumer protection issues associated with digital credit. What started-off as a market served by one lender, M-Shwari in 2012, is now a market of more than 60 lenders. M-Shwari, KCB M-pesa, Branch and Tala might be familiar names in Kenya’s digital credit market, but chances are most people will not be familiar with either Kakitu or Tajiri, two of the newest kids on the block. Kakitu, in Kenya’s urban slang loosely translates to ‘something small’ and is often used to connote a financial handout or extortion, while Tajiri means a rich person in Swahili.

Digital credit is increasingly being offered by entrants from outside the regulated sectors such as Kakitu and Tajiri. However, this is more by default rather than by design. Regulation of lending in Kenya is done by institutional form and not by activity. For instance, the Banking Act is for commercial banks, the Microfinance Act for deposit-taking microfinance banks, and the Sacco Societies Act for deposit-taking Saccos. The majority of digital lenders on the other hand do not take deposits but lend their own funds against their balance sheets. Most of these lenders are neither licensed nor regulated. As pointed out in the first article, some lenders have been pushing the envelope of acceptable practice.

Some of these practices are highlighted in a publication by FSD Kenya that presents the findings of a study aimed at understanding the conduct and practices of digital credit providers in Kenya. Some of the key takeaways are highlighted below:

1. The digital credit market in Kenya has low entry and exit barriers: In September 2018, the two main app stores (Google Play and Apple’s App Store) had approximately 110 mobile apps by 74 unique developers listed as offering digital credit. As at April 2019, 65 of these apps had been pulled down from the app stores, while 47 new ones developed by 43 unique developers had emerged. There was an unprecedented rise in the number of apps published in 2018, from 14 in 2017 to 49 in 2018.

2. As a result, fraudulent ‘lenders’ have emerged: Not everyone with a digital credit app is genuinely engaged in the business. Some are engaging in questionable and fraudulent practices such as taking deposits from the public even though they are not licensed to do so. Some lenders require the payment of a registration fee by potential borrowers without the guarantee of issuing the loan.

3. Consumers have little control over their data: All the lenders leverage a wide range of consumers’ telecoms, applications, transactional and social media data. While most of the lenders in the study have a data privacy policy, only a handful (3) give the customers the right to use, access and correct their data held by the lenders. Clauses that give the lenders the sole discretion in the use of their customer data are common. All the lenders reviewed share customer data with third parties with credit reference bureaus and mobile money operators topping the list of third-parties receiving borrower data. Accepting the lenders’ general terms and conditions is the market practice for obtaining consent to share borrowers’ data.

4. Compliance with credit reporting requirements is disparate across lenders: banks are required by law to submit full-file credit data while deposit-taking Saccos are required to submit negative data and can also report positive data. Non-bank digital lenders are not legally mandated to share borrowers’ credit histories with credit reference bureaus (CRBs). However, they can voluntarily submit borrowers’ positive and/or negative information to any of the three licensed CRBs. In the study, only one bank was consistent in submitting the credit data to the three CRBs over the two borrowing cycles as required by law. The rest of the banks were inconsistent in complying, either by failing to submit data to all the three CRBs or failing to submit to any CRB altogether. Only one non-bank lender was consistent in voluntarily submitting data to the three CRBs.

5. Pricing is still sticky downwards: Digital credit held the promise of driving down some of the costs associated with lending, other than risk. However, the cost of loans have remained relatively high. Some lenders charge a credit life insurance premium as part of the loan while others charge borrowers for moving the loan proceeds from the lenders’ mobile wallet to the borrowers’ mobile money wallet. All these costs add to the cost of borrowing. There were five different types of fees charged by lenders in the study.

Inevitably, there have been growing calls to develop regulation that covers all lenders, banks and non-banks. Consumers have a collective interest in many elements of regulation and there are several ways by which regulation can impact on consumers and on the development of the sector. Regulation is frequently misrepresented as simply being about restricting what market actors can do, yet it can actually support effective market function. For digital credit, a starting point would be regulation that not only reduces the risk of harm to all consumers (whether borrowing from M-Shwari or Kakitu) but also shape incentives for all lenders, regardless of form, to develop products that are in the long-term interest of the client.

However, it is vital that the design and implementation of such regulation does not inhibit the development of new value-adding financial solutions. It is also about ensuring that the approach continues to create opportunities and incentives for innovation that enhances competition and shapes cost, price and thus affordability.

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Francis Gwer is Project Manager for Regulation at FSD Kenya.

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