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Are digital loans a risk to financial system?



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Reading press reports in the last few months, one would get the impression that besides corruption and the public debt question, the rise of digital loans and their use in betting is a very important risk in Kenya.

In various reports in the formal press and other global publications, the question has been asked whether the rise and popularity of digital loans may be a risk that is not fully appreciated and even less competently regulated.

Kenya has had success in the telecommunications industry and this is most evident in the expansion of services provided through mobile telephony.

Mobile telephony payment services have been an unqualified success in the country and this has led to a lending that is not provided through the formal loans processes.

These loan products through mobile lending have taken on three categories starting with direct loans by banks (Mshwari and Eazzy cash), lending through services such as M-Kopa Solar and standalone lending applications such as Tala and Branch.

It is true that the last category of mobile phone applications has grown in numbers and breadth of services and many Kenyans are able to get loans and cash advances through them with minimum paperwork and regulatory controls.

By virtue of lower thresholds applied to applications for loans, the number of loans provided through these services have not only grown but many individuals have more than one loan facility running concurrently.

Added to the rise of betting channels in Kenya and their use of mobile telephony as access points, the claim is that an explosion in betting is driven mostly through these loans and this leads to higher defaults with possible adverse consequences to individuals, firms and the financial system.

The rise of new industries and new configuration of services may require the reorientation of regulatory policy.

Prudent setting of policy makes it imperative to determine what risks exist to consumers and traders and to apply rational principles for their regulation.

So far, the calls to ban or tightly regulate the digital lending industry in Kenya is well-meant but is not supported by an identification of the real risks that require government intervention.

Let us begin with an examination of the size of digital loans in comparison to loans in the formal banking system.

A 2018 report by the Central Bank of Kenya (CBK) states that the size of commercial loans was KES 2.33 trillion in 2016 close to 30 per cent of Kenya’s GDP working out to an average loan size of Sh400,000.

On the other hand, the average digital loan was Sh4,000 as reported by the Kenya Integrated Household Budget Survey 2016 (KIHBS) and therefore 100 times smaller.

Given these scales, it is unlikely that digital loans pose an immediate systemic risk to Kenya’s financial system.

An examination of the default rates in the digital loan sector can illustrate whether their growth poses a systemic risk in the medium to long term.

In the same year 2016, the reported default rate for non-performing loans given by banks was 9.69 pc while that of digital loans given by commercial banks was 11.4 percent.

Given the low threshold for digital loans, the difference in non-performing rates is not significant.

Added to the fact that digital loans are even smaller, this difference in terms of the total amount at stake still swings towards banks. The credit risk is still on the bank side.

It is also claimed that the explosion in gambling is driven entirely by the increased access to digital loans.

In reality, credit info reported that only 3 per cent of people that borrowed digital loans were reported to have borrowed for betting purposes.

This category of borrowers comprises the smallest share of total digital loan borrowers.

Business investment was the leading cause of borrowing.

This exposes as a fallacy the notion that digital loans are driving the explosion in betting in Kenya.

If the issue at stake is to regulate mobile phone enabled betting, then that ought to be discussed separately from digital loans.

Given that 97 per cent of people find utility in digital loans unrelated to betting, it is preposterous to regulate digital loans as a strategy to curtail betting.

A fourth factor that has been cited in the moral panic driving the quest to regulate digital loans is that there has been a rise in individuals blacklisted by credit reference bureaux.

It is preposterous to attribute the entire growth of blacklisted individuals to betting and digital loans.

This is because the total stock of both Kenyans using mobile phones and those holding bank accounts has risen in the same period and this has independently driven the demand for credit risk ratings.

With this increase, the number of defaults would go up irrespective of the existence of digital loans.

This is a flawed cause and effect hypothesis with no justification.

On the supply side, there exists a solid business case for digital lenders to monitor and control serial defaulters because they have capital at stake. They are in the business of maximising profits, after all.

The digital lending platforms are replete with data that the proprietors may use to craft an accurate risk profile for all their clients.

With this in mind, it is unlikely that they would casually lend their money to borrowers unlikely to service their loans.

This means that their own self interest will reduce the share of non-performing loans.

Financial sector regulators must be on the lookout to understand risks that result from innovations such as digital loans.

That stated, this policy discourse should concentrate on determining real risks rather than be driven by the moral panic from cultural views against betting.

Mr Owino is the CEO, Institute of Economic Affairs Kenya; Mr Wa-Kyendo is a Research Officer at IEA Kenya.