In April 2021, a <a href="http://kenyalaw.org/kl/fileadmin/pdfdownloads/bills/2021/TheCentralBankofKenya_Amendment_Bill_2021.pdf" target="_blank" rel="noopener noreferrer">bill</a> that proposed licensing digital lenders was passed by the Kenyan parliament and is now pending approval from the national assembly. Among other things, this bill would require all digital lenders to submit product pricing to the Central Bank of Kenya for approval before launching, a move that seeks to lower predatory interest rates. Further, non-performing loans would be capped at <a href="https://www.businessdailyafrica.com/bd/economy/mobile-phone-lenders-risk-closure-in-cbk-bill-3376538" target="_blank" rel="noopener noreferrer">twice the amount of the initial loan defaulted</a>, which means lenders won’t be able to perpetually increase the amount to be paid back through late-payment fees.

Much has been <a href="https://www.bloomberg.com/news/features/2020-02-12/tech-startups-are-flooding-kenya-with-apps-offering-high-interest-loans" target="_blank" rel="noopener noreferrer">written</a> on the fintechs that have flooded the Kenyan market since 2016. FSD and CGAP published alarming <a href="https://www.cgap.org/blog/kenyas-digital-credit-revolution-five-years">evidence</a> in 2018 showing that in addition to a saturated digital lending market, an increasing number of digital borrowers in Kenya became over-indebted, which furthered them into <a href="https://www.microsave.net/2019/09/18/11310/" target="_blank" rel="noopener noreferrer">poverty traps</a>. Digital lenders such as OKash and Branch reportedly publicly shamed debtors by <a href="https://restofworld.org/2020/okash-microlending-public-shaming/" target="_blank" rel="noopener noreferrer">texting their friends, family, and colleagues</a>. Further, high-interest rates and non-transparent fees resulted in APR’s above <a href="https://qz.com/africa/1975202/kenya-prepares-to-crack-down-on-high-interest-loan-apps/" target="_blank" rel="noopener noreferrer">400 percent</a>, making it more difficult for some low-income borrowers to repay. In some instances, repayment was possible, yet it meant sacrificing other payments like food, medicine, or school fees. And finally, millions of borrowers were reported to credit bureaus for <a href="https://www.cgap.org/research/publication/consumer-protection-digital-credit" target="_blank" rel="noopener noreferrer">loans smaller than $10</a>.

During the COVID crisis, the Kenyan Central Bank issued a number of measures to ease the debt burden on borrowers, such as <a href="https://www.centralbank.go.ke/uploads/press_releases/850440997_Press%20Release%20-%20Credit%20Reference%20Bureau%20Regulations%20-%20April%202020.pdf" target="_blank" rel="noopener noreferrer">forbidding</a> unregulated mobile-based and credit-only digital lenders from reporting any late borrowers to credit bureaus. Although this helped ease debt stress on consumers during the crisis, this drove many digital lenders out of the market as levels of default skyrocketed, leaving <a href="https://www.theelephant.info/data-stories/2020/09/18/covid-19-regulatory-measures-could-widen-kenyas-financial-access-gap/" target="_blank" rel="noopener noreferrer">many Kenyan borrowers underserved</a>. The entire loan market in Kenya shrank due to COVID-19; today, these platforms lend around <a href="https://www.businessdailyafrica.com/bd/opinion-analysis/editorials/cbk-regulation-of-digital-lenders-is-long-overdue--3378386" target="_blank" rel="noopener noreferrer">2 billion shillings a month</a>, compared to 4 billion shillings in early 2020.

The proposed bill by the Central Bank of Kenya unfortunately will not address the issue of making digital credit both safe and accessible. The bill focuses on product pricing only, and it doesn’t address the underlying challenge of digital lending platforms: a weak credit assessment model. Such a model <a href="https://www.ted.com/talks/shivani_siroya_a_smart_loan_for_people_with_no_credit_history_yet?language=en" target="_blank" rel="noopener noreferrer">extracts large amounts of data from the borrower’s phone</a> and runs it through algorithms that approve or deny the loan. Many digital lenders mitigate the risk of a light-touch credit assessment with above-market APRs and hidden late payment fees, thus being able to generate profit and returns to their investors.

The primary problem is digital lenders do not measure the capacity of someone to repay, but their willingness to repay, and these are drastically different concepts. Willingness refers to the genuine disposition of a person to pay back their loan. Capacity, on the other hand, refers to the person’s ability to generate enough money in the future to pay back the loan without having to forgo essential expenses.
<blockquote class="pullquote--left">Digital lenders do not measure the capacity of someone to repay, but their willingness to repay and these are drastically different concepts.</blockquote>
For example, I might score very well on a digital risk assessment. My geo-trace shows I go to work every day, my call log shows I call my mom regularly, and my browsing history shows I do not engage in sports bets. These measurements indicate I am a responsible citizen who complies with her duties, suggesting that I have a high willingness to repay a loan. However, I might have astronomical medical expenses that the digital lender is unable to detect. Or I might be sending significant remittances to my family. Both of these relate to my repayment capacity and are measures that digital lending apps tend to ignore in favor of automated decision-making based on more readily available data.

By comparison, traditional banks run thorough credit risk assessments, sometimes so thorough that they are slow and expensive. These banks have credit committees and risk analysis departments that challenge relationship managers on the loan proposals they present. The result is that most people granted a loan have the means to pay it back. This method excludes the majority of the world’s population from the financial system, however, it also ensures that most people who are granted a consumer loan actually have the capacity to repay.

So where do we draw the line? How do we expand access to credit to low-income people and informal workers and also protect them from default? How can we measure their capacity to repay in a cheap, digital, and rapid manner? Should we prohibit alternative, digital, phone-based metrics that only assess someone’s willingness to repay?
<h2>A Possible Solution</h2>
The answer could be a measure in between. One idea is that the Central Bank of Kenya could only grant a license to digital lenders that incorporate the borrower’s capacity to repay in their credit assessment algorithms. This means, finding a way to measure, prove and integrate the person’s real income and expenses. Another option could be asking lenders to integrate proxies for repayment capacity. For example, mobile money records could be matched with the borrower's geolocation to determine where and why they are being paid and predict how stable his or her income is. Coupled with strong data protection measures, this and similar metrics could help curb the high default rate and loan-stacking among digital borrowers in Kenya without causing financial exclusion.

Further, as suggested in a <a href="https://centerforfinancialinclusion.org/making-digital-credit-truly-responsible/" target="_blank" rel="noopener noreferrer">publication produced by CFI</a>, the Central Bank of Kenya should withdraw a digital lender’s license upon surpassing a threshold percentage of non-performing loans as a share of the total loan portfolio. This would force the lenders to improve their algorithms and creatively design more capacity-measuring metrics. And finally, the CBK should explicitly require licensed digital lenders to cross-check an individual’s loan performance with each other before issuing further credit to prevent loan-stacking. Although the Digital Lenders Association of Kenya (DLAK) advocates for digital lenders to be able to receive and submit borrower information to credit bureaus, this practice has not addressed loan stacking in the past and only served to blacklist millions of borrowers for small amounts. Therefore, digital lenders should be allowed to view and report outstanding loans, yet with very limited power to blacklist a late borrower.
<blockquote class="blockquote">The CBK should explicitly require licensed digital lenders to cross-check an individual’s loan performance with each other before issuing further credit to prevent loan-stacking.</blockquote>
Kenya cannot go back to the old bank-driven model which financially excluded most of the population, yet Kenyans cannot keep paying the price for the financial experimentation of tech startups. Digital credit should be responsible, affordable, and inclusive. With this new bill, the Central Bank of Kenya is getting closer to achieving it. However, the root cause of the problem is the evaluation algorithm and the business model that stems from it. Without addressing this, little will change for Kenyan borrowers.

Digital Lending in Kenya: Willingness vs. Capacity to Repay

Kenya

Sub-Saharan Africa

Alternative Data

Financial Technology

Client Treatment

Consumer Protection

Credit

Credit Provision

Digital Credit

Financial Service Providers

Fintechs

Interest Rates

Over-indebtedness

Responsible Digital Finance

Underwriting

Blog Post

Digital credit has emerged as a new and profitable service offering that has great potential to increase financial inclusion. Yet, if not carefully managed, digital credit also runs the risk of excluding, over-charging, and over-extending customers.

Seven years since the first digital credit product launched, the market in Kenya has grown exponentially and hosts a diverse ecosystem with more than 50 supply-side actors. The phenomenal expansion of digital credit in Kenya serves as a test-bed for the product and offers lessons for digital credit suppliers and regulators around the world.

SPTF and the Smart Campaign commissioned MicroSave Consulting (MSC) to study the dynamics of the digital credit sector on both demand and supply sides. The output of the study was a <a href="https://content.centerforfinancialinclusion.org/making-credit-truly-responsible-webinar/">comprehensive report on the current state of digital credit in Kenya</a>. It looked at the evolving challenges in digital credit and made recommendations for a more responsible and customer-centric delivery of the product.

With participation from Smart Campaign Senior Director Alexandra Rizzi, this webinar:
<ul>
 	<li>Helps participants understand the digital credit landscape in Kenya</li>
 	<li>Assesses the progress and challenges around making digital credit responsible and inclusive</li>
 	<li>Recommends steps towards a more responsible delivery of digital credit</li>
</ul>

Making Digital Credit Truly Responsible Webinar

SPTF

The Smart Campaign

Customer Centricity

Delivery Channels

Default

Digital Financial Services

Enabling Environment

Nano Loans

Policy, Regulation and Government Initiatives

Product Pricing

Webinar

All is not well in the country that pioneered mobile credit. A new <a href="/making-digital-credit-truly-responsible">report on digital credit in Kenya</a> from <a href="https://www.microsave.net/">MSC</a>, commissioned by <a href="/about/what-we-do/the-smart-campaign">the Smart Campaign</a> and the <a href="https://sptf.info/">SPTF</a>, shows that with continued dramatic growth rates, the sector also experiences cripplingly high default and delinquency, enabled by poor business practices and weaknesses in both the credit reporting infrastructure and regulatory jurisdiction.

Most notably, the report reveals very high rates of delinquency and default. Among active digital loans, more than a quarter are non-performing. About 2.2 million Kenyans are said to have delinquent loans. In some cases, liberal use of refinancing and rescheduling hides this level of delinquency in lender portfolios. At the same time, the report points out that about half of these non-performing loans are for amounts less than $10. These findings are broadly consistent with results cited by CGAP in 2016, which found that 50 percent of digital borrowers in Kenya repaid their loans late, and 12 percent defaulted.
<blockquote>Despite continued growth of digital credit in Kenya, high delinquency, default and interest rates persist in the market and credit bureaus haven't yet caught up with the digital age.</blockquote>
The report also details shortcomings in credit reporting, given that many digital lenders neither consult nor report to the credit reporting bureau as fully or regularly as they should. The credit reporting bureaus were clearly set up for a pre-mobile era, which suffer from issues related to inclusion of all types of lenders, frequency of uploading data (monthly, when daily is more relevant for today’s short term loans), and ease of connection among all the players in the credit reporting ecosystem. As a result, many lenders are not consistently using credit bureaus—neither ensuring that the information is updated and correct, nor fully consulting it prior to lending.

Pricing is also an issue. The market leader, M-Shwari, which accounts for about two-thirds of all digital loans, charges an annual percentage rate (APR) of 90 percent. The low-price option provided by Kenya Commercial Bank is a fairly reasonable 44 percent APR, but the high end of the price range includes providers charging APRs well into the hundreds. Granted that these are small, short term loans where interest payments are not expected to be sustained for an entire year. Nevertheless, the promise of digital to bring down prices does is not yet in sight.

Other issues noted in the report include non-transparency regarding portfolio quality, identity theft, misuse of client data, multiple borrowing and loan bicycling by clients, and client use of loan proceeds for sports betting.

The picture that emerges suggests that the still-exploding market of very small, “nano” loans needs to be brought into more orderly operation. Consumers and providers are operating in risky ways. The current state of the market is not beneficial for either.
<blockquote>Raising the bar for blacklisting customers and public awareness about defaulting on loans are among our recommendations for improving digital credit.</blockquote>
One issue specific to this nano-loan market concerns the reporting of very small non-performing loans to credit bureaus, with negative consequences, such as curtailing of access to credit, for hundreds of thousands of borrowers. MSC, the Smart Campaign and SPTF recommend that regulations be put in place such that delinquencies and defaults among loans below some fixed amount not be reported to the credit bureau (whether US$2, $5 or $10 – the report actually recommends a cutoff of 5% of the monthly per capita GDP). It also recommends that the government launch a public awareness campaign about how credit bureaus work and the consequences of default so consumers will better understand the risks involved in borrowing.

The regulators, credit reporting agencies and lenders in Kenya are aware of these concerns and working to improve the situation. A new association of digital lenders (Digital Lenders Association of Kenya) has been formed to create consumer protection standards and the central bank is exploring ways to upgrade the credit reporting ecosystem. The Smart Campaign recommends that both lenders and regulators consider adopting the <a href="http://www.smartcampaign.org/about/smart-microfinance-and-the-client-protection-principles/digital-credit-standards">digital credit standards</a> and <a href="https://www.smartcampaign.org/tools-a-resources/1210-handbook-on-consumer-protection-for-financial-inclusion">model regulations</a> covering issues ranging from transparency, to the fair use of algorithms, to protection of customer data.

Kenya’s unprecedented dynamism in mobile money, digital credit and financial inclusion is envied across the world. If authorities and providers can bring the participants in these sectors into a better-functioning marketplace, Kenya will benefit greatly from the innovation the country continues to spawn.

Red Flags in Kenya’s Nano-Credit Market

Keeping Clients First

Transparency

&gt; Posted by Sergio Guzmán, Lead Specialist, The Smart Campaign, CFI

<a href="http://www.pbs.org/newshour/extra/speakout/us/july-dec12/Saloni_09-18.html"><img class="alignright wp-image-8094" style="border:0" alt="" src="http://centerforfinancialinclusionblog.files.wordpress.com/2012/10/microfinancegroup1.jpg" width="270" /></a><a href="http://www.smartcampaign.org/">The Smart Campaign</a> will soon launch its Certification Program on client protection for microfinance institutions (MFIs). In this second post in a series, Sergio Guzmán uses his experience from the field to shed light on standards that are often overlooked by MFI managers but that are a crucial part of client protection. 

When I talk with microfinance practitioners about interest rates they often say, “Clients don’t care about the interest rate; they care about the installment amount and how quickly you can disburse the loan.” Also, I’ve often heard from providers the following gem: “The most expensive loan is the one you never take out.”

In my experience, it’s absolutely true that clients are very concerned with how expensive loans are going to be relative to their monthly income, and it’s also true that when seeking a loan, clients want the money now if not sooner. But providers should not let those client traits become an excuse for non-transparency in price structure and calculations.

Let me explain:

In many countries with Annual Percentage Rate (APR) regulations , I have seen providers present clients with a monthly nominal rate. “So that clients understand better,” they say. This of course is sometimes a marketing ploy, since 3 percent a month might seem cheaper than 36 percent a year. However, if all costs have been incorporated into that 3 percent figure, it does not violate acceptable practice.

What does violate standards is when providers confuse clients about total costs by charging fees and then stating a monthly charge that omits them; that is to say, instead of the above 3 percent monthly interest rate, a provider advertises a 2.5 percent monthly rate, not mentioning additional fees (credit bureau check, insurance, disbursement fee, administrative fee, paper fee, among others) that would have to be counted in calculating a fully transparent APR. The argument that these fees are not included in the advertised interest rate because they are not strictly interest charges is a half-truth at best, and designed to obscure the facts from clients. Chuck Waterfield illustrates this superbly in his webinar: <a href="http://www.mftransparency.org/resources/understanding-the-price-curve-in-microfinance/">Understanding the Price Curve in Microfinance</a>.

The Smart Campaign standards require interest rates to be presented in a manner that avoids confusing clients about the total costs of the loan. The presentation of pricing should also include a format that would in theory allow a client to make a direct comparison to competitors. APR, when calculated to incorporate all fees effectively capture additional costs charged by providers and aggregate them to an understandable annual fee that can be compared across providers.

Providers should move away from using fees as a way to reduce the stated interest rate. Let’s say it straight: tactics like this aim to trick the client. After all, if providers try so hard to make their prices look cheaper, doesn’t that suggest  that clients ARE price sensitive and they DO care about interest rates?

Image Credit: <a href="http://www.pbs.org/newshour/extra/speakout/us/july-dec12/Saloni_09-18.html">PBS</a>

Have you read?

<a href="http://cfi-blog.org/2012/10/11/straight-talk-on-client-protection-whats-internal-audit-got-to-do-with-it/">Straight Talk on Client Protection - What's Internal Audit Got to Do with It? </a>

<a href="http://cfi-blog.org/2012/09/28/can-providers-take-more-responsibility-for-client-protection-the-smart-campaign-says-yes/">Can Providers Take More Responsibility for Client Protection? The Smart Campaign Says Yes</a>

<a href="http://cfi-blog.org/2012/09/19/new-smart-note-responding-to-complaints-at-tameer-bank-pakistan/">New Smart Note: Responding to Complaints at Tameer Bank, Pakistan</a>

Straight Talk on Client Protection – Hiding Fees When Quoting Interest Rates

Smart Certification

Brazil

Latin America and The Caribbean

Mexico

Challenges and Crises

Consumer Credit

Entrepreneurs of MSMEs

Equity Investing

Financial Health

Financial Inclusion Strategy

Housing Finance

Impact Investing

Microfinance

MSME/SME Finance

Partnerships

Resilience

Responsible Investing

Underserved Groups

Podcast

Most of Mexico’s people lack access to a formal bank account. Accion has worked in Mexico for decades to create a thriving and competitive financial sector that embraces innovation and protects its clients.

[embed]https://soundcloud.com/accioninternational/the-pandemic-is-a-moment-to-get-in-touch-creditas-ann-williams[/embed]

&nbsp;

"The pandemic has been a great learning experience for us and an opportunity to be even closer to our customers in a moment of crisis," says Ann Williams, COO of Creditas, a digital platform that offers financial products and consumer solutions in Brazil and Mexico. The company began by offering asset-backed loans to provide "lower interest rates, longer terms, and lower payments that can fit into the pocket of our customers". In the tenth and final episode of VentureKast: Rebuild, Ann explains how the fully digital company has reached out to their customers — especially small business owners who have been deeply affected by the COVID-19 crisis — to restructure loans and create new products that address their challenges.

"Brazil has one of the highest interest rates in the world for consumer loans and the banks are some of the most profitable in the world," says Ann, who elaborates that their high-cost structures and focus on shorter-term, "toxic" debt have created a need for better, cheaper loans. "There’s been a push among fintechs like Creditas, along with central bank and policymakers, looking to create opportunities for consumers to access more fair financial products," she says. By leveraging a digital platform, Creditas can give customers more information and more opportunities, even during this challenging time. Ann reminds us that "it’s always the moment to work to build something better for the underserved," and she asserts that Creditas’ resolve to enrich the relationships with their customers is as strong as ever.

For more conversations about how the pandemic is shaping our industry, listen to the rest of our <a href="https://www.accion.org/series/venturekast-rebuild">VentureKast: Rebuild season here</a>. Host and co-managing director of  <a href="https://www.accion.org/how-we-work/invest/accion-venture-lab" target="_blank" rel="noopener noreferrer">Venture Lab</a>, <a href="https://www.accion.org/bio/vikas-raj" target="_blank" rel="noopener noreferrer">Vikas Raj</a> interviewed industry leaders every Thursday for the last 10 weeks about how COVID-19 has impacted their work.

"The pandemic is a moment to get in touch" — Creditas’ Ann Williams