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Why new digital lending rules may hurt consumers

By Amrit Soar and Josphat Nthata

The recently published Central Bank of Kenya (Amendment) Bill, 2021 (the “Bill”) is the latest attempt by parliament to regulate the previously unregulated digital lenders. In 2020, there were two different attempts to amend the law to give the Central Bank of Kenya (CBK) power to regulate digital lenders. The Bill defines "digital credit" as a credit facility or arrangement where money is lent or borrowed through a digital channel, that is, the internet, mobile devices, computer devices, applications and any other digital systems as may be prescribed by CBK.

If the Bill is enacted into law, all digital lenders will be under the control and regulation of the CBK. New digital credit providers will be required to be registered and licensed by the CBK before conducting any business. Similarly, any person who, before the coming into force of the proposed law, will have been in the business of providing credit facilities or loan services through a digital channel and not regulated under any other law will have to register with CBK within six months of coming into force of the Bill.

The Bill requires the CBK to make regulations to govern digital lending within three (3) months from the date of its passage into law. The regulations are required, among others, to provide for the registration requirements for digital credit businesses, management requirements for digital credit providers, anti-money laundering and measures for countering financing of terrorism, credit information sharing, data protection, consumer protection and reporting requirements for digital credit providers.

Regulation has its own advantages and disadvantages. On the one hand, regulation may promote openness in product markets therefore providing the necessary conditions for research and innovation. On the downside, regulation may hamper the development of new, improved products and create barriers to innovation by increasing uncertainty and costs. Indeed, the success of mobile money in Kenya may be partly attributed to the absence of regulation in the sector which gave innovators room to innovate without the risk of falling afoul of the regulator. For instance, at the time of the launch of M-Pesa in Kenya, the CBK found that it had no clear authority over non-bank funds transfer. Thanks to this regulatory gap, CBK decided that it would not interfere and consequently issued a letter of no objection to the launch of M-Pesa.

It is probable that in a bid to protect the consumers, CBK’s regulations will seek to regulate the interest rates to be charged by the digital credit providers. The regulation of interest and capital requirements may affect the digital lending space with adverse consequences to the same consumers that the Bill seeks to protect.

It is worth noting that the digital credit providers are serving a specific segment of the market that has been, for a long time, locked out of the credit market. While banks and other traditional financial service providers are currently offering mobile and internet banking services, these services are meant to serve the “banked” segment of the population. Further, it is very unlikely for a bank, a microfinance or a savings and credit cooperative (Sacco) to give credit to a customer without any security. Banks will usually require security in the form of a title deed, motor vehicle logbook or at the least, a payslip accompanied by a life insurance cover. Saccos, which are thought to have the least security requirement, will only give credit to a member against the member’s savings or a guarantee by another member. Many Kenyans cannot meet the security requirements to access credit from these institutions. In contrast, digital lenders are ready to give credit to their customers without any security.

Due to the structure of their lending models, digital lenders are exposed to high risk of default compared to banks, microfinance and Saccos. This justifies at least in part, the need for them to charge high interest rate to hedge against the high risk of default by their customers.

Studies have showed that introducing an interest cap locks out SMEs from bank credit market as they are considered high risk.  Without a cap, lenders have the freedom to price each loan based on the risk involved on a case-by-case basis. This explains why the introduction of interest cap by the CBK in 2016 in the hope that SMEs would have better access to credit failed to yield the desired outcome and the interest cap had to be lifted.  Any attempt to regulate interest charged by digital lenders would likely limit access to credit by the segment of the market which they are currently serving.

While it is important to protect consumers from unscrupulous digital lenders, there is need to strike a balance between protecting the consumers and ensuring that they continue to enjoy the services offered by digital lenders.

The Consumer Protection Act establishes the Kenya Consumers Protection Advisory Committee. The role of the committee includes the promotion or participation in consumer education programmes, providing advice to consumers on their rights and responsibilities under appropriate laws and making available to consumers general information affecting the interest of consumers.

Given the delicate balance that should be struck in protecting the consumers while at the same time ensuring that they continue to enjoy credit services from digital lenders, it would be appropriate for the government to capitalise on consumer education to empower the consumers with information, which would enable them to make the right decisions on whether to take credit from digital lenders.

The government can also protect consumers without stifling the growth of digital lending by working collaboratively with stakeholders. Significantly, digital lenders are currently self-regulating through the Digital Lenders Association of Kenya (DLAK). DLAK’s code of conduct has provisions that are meant to protect the consumers by prohibiting unethical conduct. The government could empower the association by requiring all digital lenders to be its members so that any member that contravenes the code of conduct is expelled from the association and ceases to be eligible to provide digital credit services.

The article was featured in the Business Daily on 29 June 2021 and can be accessed here