Spotlight- Credit on the Cusp: Strengthening credit markets for upward mobility in Africa

How should policy makers and financial service providers deal with the forces set in motion by the explosion of digital credit in Kenya? We examine some key considerations which could help address this issue by looking at FSD Africa and BFA’s collaborative report, while offering some of insights from our own field research on small shop owners in Nairobi.

Duka Diaries: How we ran into the missing middle

A handful of Sub-Saharan African countries have experienced double digit growth rates over the last decade. While these countries undoubtedly deserve all credit due for the “Africa Rising” narrative, the view from our side here in Kenya paints a slightly more nuanced picture.

The reality is that a significant number of individuals in these emerging economies have remained unable to access formal /traditional financial services. To add to this, an alarming proportion of the labour force (74%) ¹ which has driven this growth, is actually self-employed and informal.

This is why Gravity is working towards improving access to finance for this segment of self-employed, small business owners.

Over the last few months, we’ve been conducting a pilot with small shop, i.e ‘duka’ owners in Nairobi. From the field visits and interviews we’ve conducted, we observed two broad trends.

1. Widespread data scarcity is problematic for service providers.

We’re far from being the first ones to have realised that there’s a significant lack of data on the small business owner population.

This leads to a tendency to take a blanket approach towards various sub-groups, each with different business practises, risk preferences and investment needs, by clubbing them under a single “Bottom-of-the-Pyramid” or micro-enterprise label. Ultimately, this inhibits both policy makers’ and lenders’ capacities to accurately address their needs and offer corresponding products.

2. Variations in small business owners’ characteristics are not fully captured by existing frameworks

Related to the problem of data scarcity, we also noticed among our sample that small business owners were extremely varied in terms of income, level of formality and financial history.

However, we identified a significant concentration of business owners that shared 3 main characteristics:

1. They were neither completely formal nor informal,
2. They didn’t correspond to the income levels which are commonly the norm to qualify them as “survivalist”, but were far from breaking-even and/or expanding, and
3. They had previously never borrowed from a bank or micro-finance organization but instead from digital lending apps or community savings groups.

Identifying roughly the same segment we encountered as “Cuspers”, the report gives an overview of the constraints faced by them in 3 emerging economies: Kenya, Nigeria and South Africa. Published in 2016, revisiting the report today is relevant given the current state of digital credit markets and trending interest caps. Since our experience has mostly been based in Kenya, we’ll be zooming in on this case.

“Squeezed” in Kenya : The unfulfilled promise of digital credit

Referring to the situation in Kenya as “squeezed” in terms of the credit market for the Cuspers, the report serves as a prelude to the concerns now being voiced by many who view the rapid expansion of digital credit in Kenya as a crisis waiting to unfold. ²

A competitive digital lending market has certainly extended access to credit for many Kenyans previously excluded from formal bank-led borrowing. However, increased competition has not pushed the cost of borrowing down, with many lending apps often charging interest at rates well above those charged by traditional banks.³ This, coupled with short loan maturity periods, has gradually accumulated into high rates of non-performing digital loans.

This underpins our belief that improving ease of access to credit is only half the battle when it comes to financial inclusion. The next and equally important half consists of ensuring that once accessible, the credit has the intended transformative effect on individual income growth, asset creation and overall well being rather than inducing more financial woes.

The elephant in the room: Information asymmetry

Part of why the positive spillovers of an increasingly open digital credit market remain far from being realised is because of information asymmetry. This exists at two levels.

1. Between borrowers and lenders, such that lenders, despite many of them relying on sophisticated credit scoring models, still rely on data from limited sources to determine the eligibility and terms of lending for a particular borrower, and
2. Among lenders themselves, largely because the existence of a credit information sharing mechanism via credit bureaux does not address the realities of digital lending. Specifically, while digital lenders are still obliged to report defaulters to credit bureaux, the frequency of reporting is outpaced by the speed with which digital loans are taken out.

This means that a borrower could potentially take out loans on multiple platforms within a single day without any single lender being aware of outstanding loans with the other lenders. This same borrower could then default on all of the loans and still only be reported to the credit bureau at the end of the month. In fact, in Kenya, as many as 14% of borrowers have reported paying off multiple loans from several digital lenders simultaneously. ⁴

Protection by design for financial health

Rightly so, Credit at the Cusp calls for an emphasis on financial health in markets where access to credit is “open” due to the expansion of digital lending. This includes safeguards both for consumer and lender protection, such as introducing a ‘learners license’ which restricts new borrowers activity as they become more seasoned. Another route could be a ‘last in last out’ rule, whereby the last lender to have extended credit to a client with already outstanding loans would be the last to be paid out in the event of a default. However, this would involve a credit bureau- like mechanism for more real time data sharing between these lenders.

We believe that ensuring financial health requires embedding safeguards for consumer protection within the digital credit framework, but without compromising on the benefits of ease of access. At Gravity, we’re trying to find this sweet spot by helping transform credit information sharing so that digital credit can deliver on its intended promise: economic empowerment for borrowers on the cusp.

We’ll be reporting back with more updates on our efforts to ensure financial health for small business owners. In the meanwhile, do reach out to us with any comments, questions or recommendations.

1. Bhorat, H. and Naidoo, K. (2014).Sub-Saharan Africa’s Twin Jobs Challenge. The Brookings Institution. https://www.brookings.edu/blog/africa-in-focus/2014/06/27/sub-saharan-africas-twin-jobs-challenge/
2. Carlos Izaguirre, J., Kaffenberger M. &, Mazer, R. (2018). It’s Time to Slow Digital Credit’s Growth in East Africa. CGAP. https://www.cgap.org/blog/its-time-slow-digital-credits-growth-east-africa
3. Owuor, V. (2019). Mobile-based lending is a double-edged sword in Kenya — helping but also spiking personal debt. Quartz Africa. https://qz.com/africa/1722613/mobile-money-lending-in-kenya-helps-but-also-spikes-debt/
4. Totolo,E. (2018). Kenya’s Digital Credit Revolution 5 Years On. FSD Kenya. https://fsdkenya.org/blog/kenyas-digital-credit-revolution-5-years-on/