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Overpriced digital loans in Kenya have become a “huge burden to the consumer” during the Covid-19 pandemic, says Kellie Charlotte, a financial analyst with Maitri Capital in Nairobi. Lack of regulation has left some digital lending apps charging annualized interest rates of between 150% and 500%, she says.
In January 2020, Opera, a provider of short-term mobile loans in Kenya, Nigeria and India which trades on Nasdaq, rejected claims by Hindenburg Research that annual lending rates alleged to range from 365% to 876% were predatory.
The problem extends beyond Kenya. According to research from the Consultative Group to Assist the Poor (CGAP), which analysed data from over 20 million digital loans in Tanzania, most borrowers use digital credit for discretionary consumption, rather than for productive investments.
- Borrowers defaulted on about 20% of the loans and paid late on 40%, the CGAP found, with repeat borrowers at risk of entering debt traps.
Reliance on algorithms to approve digital loans is a problem which regulators will need to address. According to the Centre for Financial Inclusion (CFI), algorithms used by digital lenders in Kenya often rely on information provided by the loan applicant which is not checked, but simply supplemented with data scraped from their mobile phone.
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That shows a consumer’s willingness to secure a loan – but does not give an objective measure of their ability to repay.
Taming the algorithms
Covid-19 exacerbated the problem of unregulated digital lending as the main Kenyan banks became more reluctant to lend, says Churchill Ogutu, head of research at Genghis Capital in Nairobi.
“Banks are offering competitive lending rates, yet digital credit-only lenders are offering exorbitant rates,” he says. Parliament wants to “level the playing field” and so is likely to approve the bill, he adds.
So far there has been no legal framework governing digital lending platforms in Kenya. The bill published on 16 April will allow the central bank to:
- set minimum liquidity and capital adequacy requirements for digital credit providers;
- approve digital channels and business models;
- supervise digital credit providers, and suspend or revoke licences.
- The bill also requires digital lenders to make their interest rates clear and explicit.
- The bill must go through three readings in parliament and get presidential approval before becoming law, and there is no clear timetable for adoption.
Assuming the legislation passes, loan terms will improve for the consumer and regulation will also strengthen protection of data shared through the lending apps, Charlotte says. Progress is likely to take time. “The initial process of implementing the regulation especially for already existing digital lenders may be a tedious and difficult process,” Charlotte adds.
The need for regulation is urgent. “Unregulated digital lending presents a huge risk to the financial sector in consideration of uncompetitive pricing and credit quality,” says Renaldo D’Souza, head of research at Sterling Capital in Nairobi.
D’Souza doubts that regulation will be capable of putting an end to exorbitant rates. Some unregulated digital operators will remain in business with customers who do not meet the minimum credit approval thresholds of regulated lenders and will be willing to pay higher rates, he says.
Still, regulation will mean that the digital lending sector will become “more competitive with pricing and product diversity being the main areas of competition,” D’Souza says. “Digital lenders will have to become more innovative to attract customers.”
Regulators will need to learn to scrutinise lending algorithms if they are to get to grips with distress caused by excessive digital borrowing.
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