In 2010, lax regulation and an oversupply of microfinance loans led to a credit crisis in Andhra Pradesh, India. The “AP Crisis” sent shock waves through the industry, forcing providers to re-focus on consumer protection and instill a duty of care throughout their organizations. They learned the important lesson that the health of their businesses were tied to the health of their borrowers.
There has been an explosion in recent years of new services offering digital credit to borrowers in East Africa, many charging 100%+ effective interest rates. One credit originator alone, M-Shwari in Kenya, has disbursed more than $1.3 billion in loans since it was formed in 2012.
These loans solve real problems for many people in East Africa, where formal credit is sparse and local moneylenders can be dangerous. However, there is a dark side to this trend. Unless digital credit providers start providing better credit, not just more loans, East Africa may be at risk of its own credit crisis. And unless governments and providers start protecting consumers better, this trend could damage consumers’ financial lives, and tragedy could follow.
These are the four trends we at the DFS Lab observe that may be driving toward a credit crisis in East Africa.
1. An explosion of digital credit providers
When M-Shwari launched in Kenya in 2012, it was rightly celebrated as a breakthrough. Nearly anyone in the country was soon able to access credit in minutes. They didn’t need a bank account, a credit score, or even a smartphone. All they needed was a SIM card from Safaricom (the most popular cell-phone service in the country), an active M-PESA account (Safaricom’s mobile money service), and minimal digital savings. Today, there are more than 15 million M-Shwari accounts in a country of less than 50 million people.
Now, there are at least 20 of digital credit providers in Kenya alone, each competing with one another to offer faster loans with fewer conditions (e.g. many no longer require borrowers to save before borrowing). And Kenya is not alone. Similar services are now live in Rwanda, Tanzania, Uganda, and elsewhere across Africa, Asia, and Latin America, driven by a mix of banks, mobile network operators, and startups.
Accessing digital credit in Kenya today is almost trivial. If you have an M-PESA account, a phone and, in some cases, an active Facebook account, you’re only a few taps away from securing an instant loan ranging from $5 — $500.
While we at the DFS Lab celebrate the expanded access to financial services, there is some chance that these loans will create financial exclusion.
For example, there are now more than 400,000 people in Kenya who will have a harder time accessing future credit because of unpaid mobile loans of less than KES 200 ($2). These people may have to pay 10x the amount of their loan to get a “clearance certificate” from the credit reference bureau, in order to get them back into good standing.
By making it easy to access credit, some of these companies may be encouraging over-indebtedness among their borrowers, which could lead to more unpaid loans and more problems in the future.
2. The return expectations of venture capitalists
We believe in the power of markets at the DFS Lab, and we work with our portfolio companies to help them secure institutional investment to get the resources they need to succeed. That said, we’re also cognizant of the all-too-common dissonance between the return expectations of venture capitalists and the nuances and realities of our target markets. If not properly managed, the push for rapid growth can lead to unsustainable business models, “down rounds,” and tremendous damage to economies and to people.
Since 2015, a handful of digital lending startups in Kenya have raised over $50 million in venture capital. While this funding has enabled them to serve millions of low-income customers, delivering a lifeline in times of need, it also comes with the expectation to “10X,” or return that capital in a liquidity event like an acquisition or IPO at a multiple of ten. That means that VC firms are hoping to be paid back $500 million in the next few years from some of these digital credit companies, which creates tremendous pressure for providers to grow their loan books and tolerate ever-increasing risk.
3. Lagging infrastructure
While innovation around digital credit has been moving at an impressive clip, the regulatory and institutional framework surrounding credit has not had time to catch up. Regulators are often stuck in legacy systems with manual processes that are unable to keep up with the pace of innovation.
Unless these regulators modernize their systems and digital infrastructure, they will be unable to prevent over-indebtedness and systemic risk. For example, with so many digital credit products on the market, consumers will be tempted to partake in risky behavior like “loan cycling,” where one digital loan is used to pay off another.
To prevent this kind of behavior, regulators should invest in better digital asset registries and digital identification systems.
Credit bureaus will need to be updated, too. For example, most traditional credit bureaus operate on “negative” data, where consumers are blacklisted for taking out loans they cannot pay back. Today, digital tools make it possible for credit bureaus to take positive data into consideration, too. For example, borrowers could use their history of paid utility bills or rent as a way to access better credit.
4. The rise of sports betting
Whether you’re in Dar es Salaam, Kampala, Kigali, or Nairobi, you’re never more than a few kilometers from a sports betting house. And with the rise of sports betting apps, you don’t even need to leave your living room to place bets anymore. According to Safaricom CEO Bob Collymore, sports betting “has now absolutely overtaken everyone else.”
Sports betting is so profitable a leading firm, Sports Pesa in Kenya, recently sponsored the Hull City Tigers, an English Premier League football team. The Tigers described the deal as “the most lucrative in the Club’s proud 112-year history.”
The problem is that customers often borrow money to place bets. We don’t have the numbers to weigh the extent of this problem, but we’ve now heard this concern from every digital credit provider we’ve spoken to as well as management at Safaricom M-PESA. One of our portfolio companies, Pezesha, a peer-to-peer lending marketplace in Kenya, has observed this as well. They note that for borrowers with moderate or high gambling use “repayment is significantly worse.”
Most digital credit providers are able to see their customers’ transaction data, which means they should know when borrowers are taking loans to place bets. We hope these providers will take a more active stance on this issue.
Digital credit in East Africa has helped people start businesses, buy productive assets, and cover unexpected life events. Many digital credit providers should be applauded for their work expanding access to financial products and services to many more people.
However, more lending is not necessarily a good thing. “Africa does not just need more credit,” according to FSD Africa, “it needs better credit.” People need more flexible loans that work with their incomes. As people pay back the money they owe, they should qualify for lower-cost loans, not just bigger loans. And competition generally should bring down the effective interest rates, where people can take out the loans they need without getting stuck in a cycle of over-indebtedness.
Regulators should update their systems, too. New digital registries should prevent loan cycling and other risky behavior. Consumers should be protected from unscrupulous lenders with disclosure and transparency requirements. Lenders should have the incentive to offer more responsible credit, instead of just bigger loans. And credit bureaus should update their systems, to allow for new data sources and better data sharing.
Responsible credit can make an enormous difference in people’s lives. But if consumers aren’t protected, these loans can also create tragedies like the ones seen in Andhra Pradesh.
By Bennett Gordon & Ben Lyon.