Posted on September 30, 2019

Digital Credit – The most pressing problem in Kenyan credit markets – Really?

The focus on the potential and real risks of digital credit, while commendable, runs the risk of taking our collective eye off the wider credit market, which has a much more significant impact on Kenya’s economy.

Recently there was a huge fuss about forest fires burning in the Amazon Jungle. Suddenly, the world seemed at the edge of a precipice as our “lungs” of the world seemed on the verge of extinction.  Imagine the producer of much of the oxygen we breathe going up in smoke!  Before I had a chance to get bothered under the skin about this, I read an article that put the whole thing in perspective.  In this draw blog I try to draw an analogy between this blowup over extensive forest fires and the growth of excited chattering that has greeted the rise of ubiquitous limited value credit delivered instantaneously over digital devices.

FSD Kenya’s current strategy 2016-2021 is predicated upon the fact that finance is the flow of resources through time and space, between individuals and organizations, so members of society can optimize managing day to day, mitigate risks and invest for the future.  In an ideal (perfect) market, this would happen seamlessly with everyone becoming better off.   Part of my work over the years at FSD has been engaging with our credit market work.  The last two years have seen increasingly alarmist conversation arising over the “wild west” nature of the latest kid on the block, digitally delivered loans. 

The explosion of digital credit in Kenya since its inception with the CBA/Safaricom solution M-Shwari, launched in 2012, has raised concern in policy, financial sector development and consumer protection circles. These largely legitimate worries, center around over-indebtedness, Credit Reference Bureau (CRB) reporting of defaulters, high interest rates, lack of regulation, source of funding among other concerns. This singular focus on the potential and real risks of digital credit, while commendable, runs the risk of taking our collective eye off the wider credit market, which has a much more significant impact on Kenya’s economy.

Financial credit involves the intermediation of resources (cash, goods or services) from those who have a surplus (savers) to those who have a deficit (borrowers). Of course, key conditions are that borrowers can productively use these resources in the present to generate enough value and be willing and able to repay at some point in the future.  In simpler terms, credit is one of the ways in which finance moves money through time.

The credit market then, can be thought of comprising all the individuals and institutions who originate, package, structure, price, deliver, receive, use, monitor, repay, collect and report credit transactions.  For the supply side (savers) in the credit market, the incentive to invest their money in this way is to earn a return while exposing their capital to as little risk as possible.   Although some savers (particularly those giving credit in the form of goods or services) decide to take on many of the functions of the credit market themselves, most give up this right to intermediaries usually for a smaller but more sure return and more security of their capital.

The main purpose of these intermediaries is therefore to keep the surplus of their depositors safe and to find useful ways of granting use of these funds for a time to earn a respectable return.  Some of the formal regulated and unregulated intermediaries involved in the credit market, include banks, Saccos, microfinance institutions, risk funds, some investment groups, savings groups, financial service associations, development finance institutions, among others. The informal credit market consists of family and friends, “loan sharks” and others. In Kenya, various government regulators exist to oversee both the stability of the intermediaries and the safety of consumers, both borrowers and savers.  Prudential (stability) and market conduct (safety) regulation is at various levels of maturity and enforcement and this leads to inconsistency in the consequences of breaches by the financial sector.  In turn this lack of uniformity leads some adventurous intermediaries to push the envelope of acceptable practice in their various offerings.   

In their lending activity, all these financial market players face the considerable problem of information asymmetry.  At the outset of relationships, lenders have limited information about characteristics of the borrower that would minimize the repayment risk.  Information such as how a borrower has handled past loans, source of repayment for the loan, number of other active loans, is both hard to come by and more importantly, can be expensive and time consuming to gather. 

In the real world this problem of information asymmetry presents itself to borrowers as a “20 page” application form, endless requests for information, getting sureties and guarantors or the over collateralization (KShs 1.5 million piece of land for a KShs 200,000 loan).  Should the lender sense a mistake in judgement about a customer in the offing, overly enthusiastic collection practices, high fees, penalties and aggressive pricing (interest rates) are the consequence of return seeking.  These practices have the collective effect of credit rationing.  A direct result of the problem of information asymmetry is a stunted regulated formal credit market and an equally robust but potentially extractive unregulated informal market as exists in Kenya.

Since its inception in 2005, FSD Kenya has been involved in efforts to expand access to appropriate credit solutions by catalyzing the development of appropriate credit market infrastructure.  Think of infrastructure as the rail network upon which the solutions can operate effectively.   In this case infrastructure consists of credit information sharing mechanisms, a comprehensive secured transaction regime and credit market regulation.  In countries with developed credit market infrastructure, credit markets have expanded by exposing the data of good and bad borrowers, enabling more appropriate collateral to be utilized and protecting borrowers and lenders with clear, complete and enforceable rules of the game.

While Kenya has made great strides in the development of its credit market infrastructure a great deal remains to be done.  That said the advancement of technology-enabled digital finance has given forward thinkers and financial sector innovators leeway to experiment with leapfrogging the pace of infrastructure development by creating alternative forms of credit on digital platforms.  This is hoped might overcome the inadequacy of current infrastructure to minimize the challenges presented by information asymmetry.

As new digital lenders come to market each month with varying degrees of success, and calls increase from far and wide to control, regulate, protect or treat small borrowers differently, it is helpful to remember that this is just the latest form of credit, that digital credit is essentially a delivery tool in a larger credit market. Please remember, despite the many issues that plague nascent digital credit, innovation in the credit market is about reducing uncertainty and transaction costs brought about by information asymmetry. 

Therefore, deal with issues that come up related specifically to digital credit but I will tell anyone who will listen, “putting out the forest fires in the Amazon is not the equivalent of solving the problem of climate change!”

James Kashangaki is Head of Inclusive growth at FSD Kenya.

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