A Tale of Two Regulators
Through a twist of fate, I’ve been lending money in emerging markets for most of my adult life. Along the way, I’ve developed an unexpected affinity for financial regulation. It all started in 2004 while volunteering in Uganda for a microfinance organization. After visiting a handful of small business owners, I had the idea to raise cash for them on the Internet. Sounds easy right? Not so much. I quickly ran into a bunch of regulation. I eventually got through it and started Kiva.org, a non-profit in 2004. Thanks to the efforts of millions of people, we were able to raise over $1B for low income entrepreneurs around the globe.
After witnessing the rapid spread of the smartphone, I started Branch in 2014. Branch’s mission is to deliver world class financial services to the mobile generation. Today, our product is an Android app which gives quick credit at varying size, term and price. So far, so good. We have over 10M downloads, making us perhaps the most downloaded lending app in the world.
I do this work because I believe that a fair and widely available credit market is an important building block of a modern society. However, the path to building it is full of ups and downs. We offer products in five countries — Kenya, Tanzania, Nigeria, Mexico and India — all of which are at different stages of a regulatory journey. I’ll spare the detailed background because the point of this post is regulation. I want to compare my experience in two markets — Kenya and India.
Kenya
After leaving Kiva in 2014, I had a lot of time to think about what to do next. I went on a few trips to assess the fintech landscape around the world. That summer, I found myself in Nairobi meeting regulators speaking about my vision for digital lending on smartphones.
“What license do I need to get started?” I asked.
The regulator said something like “Nothing! If you want to lend out your own money, just go for it!”
As an entrepreneur with no seed funding, this sounded awesome. I could get started right away. All I had to do was make a simple app that offers money. Who wouldn’t download that? It got popular fast.
This lack of regulation seems positive for the consumer. More competition in the market should lead to lower interest rates for the public right? Not always. Without regulation, any startup can get in the game. This works for everyone at first. But competition, without reputational consequences for defaulting, can be bad. Things devolve. People can use every lender. They borrow from one to pay off the other. The default rate inevitably rises as a result.
As a lender, what do you do when the default rate goes up? Simple, you just raise prices. This is a quick way to fix the economics. However, it cannot go on forever. Rising interest rates tend to lead to rising default rates. High prices just exacerbate the problem. Eventually, lenders go out of business, liquidity dries up, and the competition goes way. The consumer is left without options. This is what you would call a *vicious cycle*.
How do you break the cycle? It’s not easy, but credit bureaus are a part of the solution. Although bureaus get criticized for being part of the growing surveillance state, it is hard to imagine modern society without them. They prevent borrowing with impunity, which helps control default rates (and pricing). Furthermore, regulation is needed to require the use (pushing / pulling) of bureaus. Without enforcement, bureaus become sparsely populated depositories. Lenders won’t naturally use them. Since most lenders won’t use the bureaus, borrowers don’t care about them. This is the situation in Kenya today.
India
About one year after starting Branch, I had the idea of launching in India. The market seemed poised for a fintech revolution. For starters, the government was actively trying to remove the use of cash. Secondly, they created bank accounts for virtually the whole population. Third, the government was rolling out Aadhaar, a nationwide biometric database to enable identity verification. Lastly, the market is credit-starved. The average entrepreneur has limited options to raise cash for business or personal expenses. After raising our Series A in 2016, I got on a plane to Mumbai in order to apply for a license.
I had an interesting meeting with the Reserve Bank of India (RBI) and went home to San Francisco. The most depressing thing happened next: nothing. The application seemed to take forever. Occasionally, we got requests from them to submit a new piece of paperwork. We would fill out a form and wait. Years passed. I had a couple kids. I got interested in working in places like Nigeria and Mexico. I lost hope that we would ever launch in India.
Fast-forward to February 2019. Out of nowhere, boom! We got the license. Branch became the first digital branchless lender to receive a new license type (digital lender NBFC). It comes with a ton of requirements. The level of bureaucracy is staggering. The capital requirements are high. The monitoring is intense. There are no pricing caps, but the RBI reviews pricing continuously. They require you to use the credit bureaus. They monitor collections practices.
This all sounds bad for startups. Regulation keeps out small players; it favors the strong. It reduces the amount of competition and leads to fewer options for borrowers. On the other hand, there are some serious upsides. Regulation brings more stability in the system. Competition is slower to develop, but the competitors are stronger. The companies that get approved are less likely to collapse. In addition, competitors are kept on best behavior. They are less likely to adopt deceptive pricing or aggressive collections policies. Borrowers tend to self-regulate against over-indebtedness because they know there will be consequences in case of defaulting. Lower default rates lead to lower interest rates for everyone.
Today, Branch India is thriving. Our default rate in India is lower than anywhere. Hence, the rates we charge are relatively lower. Furthermore, we are accepting thousands of borrowers who have no formal credit file. For these, we are the first formal lender to report them into the national bureau. Over time, this gives borrowers something they never had before — financial mobility. (hundreds of) Millions of people will be able to shop their credit score to scores of lenders.
To Regulate or Not?
These were two very different experiences. One (Kenya) was fast and low quality. The other (India) was slow and high quality. As a startup that has survived five years, we were able to wait. Not every startup has the luxury of waiting so long. So I can understand both sides of the regulatory coin.
Through it all, I’ve developed an appreciation for lending regulation. For those in regulated markets, the lyric resonates “You don’t know what you’ve got till it’s gone.”
Governments can actually speed up financial inclusion by first slowing it down. Kenya became a leader in fintech, perhaps because of loose regulation. However, it’s high time for things to change. It has been 15 years since I started Kiva, and Kenya still has yet to create a license for non-bank lending. Politicians and policy makers should put an end to their inaction which is leading to a system wide collapse.
If you would have asked me 10 years ago, it would have been a no-brainer choice to choose lack of regulation. I did that when I launched Branch. But now, I can tell you: when it comes to non-bank financial services, we need regulation. It protects the financial ecosystem, the economy and most important of all: the individuals and families who rely on these services for their livelihood.
