Curbing predatory digital lending in Kenya
Eighty-three percent of Kenyans are now engaged in the formal financial system from 27 percent in 2006. Mobile money, financial innovation and supportive government policies have been attributed for this remarkable success. Kenya’s pioneering M-Pesa mobile money service, launched in 2007 and a huge factor in this remarkable feat, exemplifies why this is the case. For instance, it enjoyed an initially carte blanche telecoms-led regulatory regime from the outset. And just a year after launch, the 2008 electoral violence in Kenya made the service the only channel for payments to rural areas and elsewhere. An adaptable customer-centric business model and emotive marketing have also been attributed.
Unsurprisingly, Kenya is currently enjoying a boom in digital mobile lending, the ideal next stage after the more than average coverage of payments. According to the 2019 FinAccess household survey, about 14 percent of Kenyan adults have taken a digital loan, via mobile banking or an app, at one point or another. There have been some downsides, however. With loans easily accessed by the press of a button, what should ordinarily be good news on financial inclusion, is increasingly becoming a source of concern.
| Borrowing behaviour of Kenyans | |
| Type of borrowing | % of Adults who used a loan |
| Borrowed or attempted to borrow in the past year from any source | 56.8 |
| Borrowed from a bank or non-bank financial intermediary in the past 12 months (non-digital) | 8.6 |
| Borrowed from social network, shopkeepers, chama, employer or buyer in the past 12 months | 45.5 |
| Borrowed digitally in past 12 months | 13.6 |
| Source: 2019 FinAccess Household Survey | |
Digital loan defaults are on the rise, almost 30 percent of total defaults, according to the recent FinAccess survey. When asked, 26 percent of mobile phone banking loan defaulters attribute a lack of understanding of the terms for why, with another 28 percent saying they failed to meet their obligations because interest or repayment rates went up. For digital app loan defaulters, 7 percent and 12 percent attributed these reasons respectively as well. Unsurprisingly, the Central Bank of Kenya (CBK) has raised concerns about the seemingly predatory practices of digital lenders, as mostly poor customers, who are charged exorbitant interest rates, increasingly find the debt burden beyond their capacity.
Digital loans are the most used type of loans in Kenya, with 8 loans per borrower on average; significantly higher than 1.2 loans per borrower for commercial banks. Digital borrowers attribute convenience for their preponderant patronage. That is, even as their trust for digital banks is no more than that for traditional ones; which is very little. The demographics of Kenyan digital borrowers are distinctive: male (60 percent), urban (67 percent) and young, aged below 35 (62 percent). Digital borrowers reportedly borrow more, sell assets, or cut expenditure on crucial needs to repay loans at significantly higher levels than traditional borrowers.
| Average number of loans per person | |
| Source of loan | Number of loans per person |
| Mobile bank/app | 8.0 |
| Social network | 2.9 |
| Money lender | 2.0 |
| Chama | 1.9 |
| Government | 1.4 |
| SACCO/MFI | 1.3 |
| Commercial bank | 1.2 |
| Hire purchase | 1.0 |
| Shopkeeper | 0.3 |
| Source: FSD Kenya | |
So, even as financial inclusion has been increasing, too much acclaim, the financial health of Kenyans has been decreasing, with only about a fifth of the adult population believed to be in good financial health. Additionally, regulatory authorities find mobile lenders are increasingly used as conduits for money laundering. To address these concerns, the central bank and finance ministry plan a law to sanitize the system. But is not there a risk that in doing so, the very elements that have made the Kenyan financial inclusion revolution remarkable may be hamstrung in the process and perhaps cause a reversal of fortunes of some sorts? I use the decision tree framework to answer this question (see link in footnote for figures & references).
For Kenya, the supply constraint on financial inclusion through digital credit services relates to predatory practices of digital lenders. While banks also provide digital loans and follow the same rules as they would ordinary loans, non-bank digital lenders do not have similar but clearly positive constraints. Kenya’s low domestic savings is more than offset by its relatively easy access to international finance in both its public and private sectors. Its financial markets are quite efficient and relatively advanced for the continent. And it has no controls on the flow of capital in and out of the country, having abandoned its restrictive foreign exchange laws since 1993.
The predatory practices of digital lenders suggest no fear of punishment on the part of the perpetrators. It is abundantly clear such negative behaviour would likely change in the face of stricter regulations. Thus, the analysis does support the need for the robust rules the Kenyan financial authorities are looking to put in place.
The evidence also suggests limited choice for consumers or probably cartel behaviour. There is certainly abundant room for more competition. A digital lender which abides by the type of strict rules banks are subjected to, would clearly have a competitive advantage in the current no-holds barred regulatory environment. Because even when the new rules are in place, firms which hold themselves to a higher standard would likely get rewarded via customer loyalty and perhaps even great influence with the authorities.
Otherwise, Kenya’s digital infrastructure is above-average by the continent’s standards, the spread of internet coverage is wide and data subscription costs are relatively low. Institutional quality and governance are average but about the best in East Africa. Tax policies and the like are no more distortionary than would be the case for peer African countries. With every Kenyan expected to have a digital identification number and related biometric data in the not too distant future, due-diligence and Know-Your-Customer (KYC) issues should hardly be significant constraints thereafter.
There is clearly ample demand for digital credit services in Kenya; especially among male and young urbanites. But it is quite clear the high cost of credit acquisition is a major drawback. Still, even as prohibitive digital lending rates of more than 40 percent a month in some cases should ideally be a huge disincentive, there is still buoyant custom; albeit default rates have naturally been rising. There is clearly a need for greater financial and digital literacy. Still, even if digital borrowers understand the often-obscure fine print, they probably have little choice in the matter. Stricter regulations make sense.
In sum, the analysis suggests that with more robust rules and lower costs, greater financial deepening in Kenya via digital credit services, as has been recorded with digital payments, would likely be achieved. It also shows a potentially lucrative gap for more responsible firms to take advantage of.
Edited version of article was first published by Nanyang Business School’s NTU-SBF Centre for African Studies. References & figures available via link viz. https://nbs.ntu.edu.sg/Research/ResearchCentres/CAS/Publications/Documents/NTU-SBF%20CAS%20ACI%20Vol.%202020-21.pdf
