There is no doubt that for the most part, the loan costs in digital credit have remained stubbornly high in many markets. The explanations are varied; I will focus on two aspects that I think are the most pertinent for inclusive digital credit in emerging markets. Firstly, for some providers, high pricing is driven by the high costs of capital and higher risks associated with serving the harder-to-reach segments where there is little or no data available. Secondly, for others, it is due to inflexible pricing technology, which does not allow for personalized pricing. These are two very different issues and with different potential remedies.
The first is a structural issue in digital credit business models: many providers, especially in Sub-Saharan Africa, are reliant on foreign (USD) capital to fund their loan books. This foreign capital often requires a return on assets (ROA) that can be as much as two to three times higher than local banks (which may have mid-single digit ROA requirements). These are not the most efficient pools of capital to solve the customer value and inclusion problems we have described so far.
One of these problems is the question of whether the most invisible (thin-file) people, who have few comparable alternative options, should still get digital credit – even if the cost to reach them is (at least initially) high. Having spent time with people in this segment, I have observed how digital credit often represents not just a solution to an immediate personal or business need, but often creates a feeling of dignity, where customers value the privacy and security of access, placing a high value on being empowered with the ability to make choices. If the answer to this question is “yes, they should have access too,” then the next step needs to be to find a way of lowering the prices of loans for these customers as well.
These are business model innovation challenges for the industry, distinct from product issues. Fortunately, they are not without solutions. We see the leveraging of local balance sheets happening effectively in Asian markets such as India, where the growing digital credit market has relatively low interest rates. On the JUMO platform, we have also begun this transition in our African markets, where we operate inclusive banking service marketplaces. We are finding that local, well-capitalized balance sheets are as crucial as low-cost cloud infrastructure in creating the necessary conditions to deliver pricing value to customers on credit products.
Pricing friction is the second major issue. Digital credit that is fair to customers does not apply blanket pricing and allows customers who have built up a good credit record to access better pricing as a reward. Secondly, when customers repay their loans early, they should be able to realize a reasonable pricing discount. On the ground, we find that for many customers their digital credit experience remains far removed from these two ideas. Sadly, there are digital credit products that continue to apply flat non-personalized pricing, and for customers such as daily fruit and vegetable traders in East Africa, early settlement is routine, but are still often required to pay a 30-day loan rate, even if they only borrowed for 2-3 days. Addressing these issues is a real and attainable opportunity to deliver value to customers. Many practitioners have pointed out the need for more flexible pricing mechanisms, such as early settlement discounts, personalized risk-based pricing, and so on. This is to ensure that customers are not merely price takers. I tend to agree, we on the supply-side of digital credit need to keep each other honest; when we talk about helping customers a create a digital financial identity and generate value from this identity; surely this needs to extend to them sharing the upside of their behaviors such as good repayment or even early settlement.
Digital credit that is fair to customers does not apply blanket pricing and allows customers who have built up a good credit record to access better pricing as a reward.
I would balance all this by noting an aspect of pricing that digital credit already gets right. When assessed holistically, the costs to access it, including all transaction and opportunity costs, are far lower than in traditional banking. Poorer customers and the self-employed cannot afford time away from their work or small businesses, or high travel costs, and they are generally able to access digital credit wherever they are, saving them both money and time. Unfortunately, these benefits are fragile and can erode quickly when digital transaction costs rise unexpectedly, for example, due to the introduction of new taxes on mobile money transactions and other mobile services. The costs of reporting and compliance are also likely to increase as the digital credit industry matures and therefore becomes more regulated. While this is good and welcome from a customer protection perspective, due care needs to be taken to ensure that customers are not left carrying the full cost of this provider compliance.
Researchers and inclusion practitioners would do well to look at and more effectively standardize measurement of “total cost to access,” as it may well be a new reason people get left behind. Interestingly, pricing and “total cost to access” is probably the area that will potentially open up the digital financial services market to large technology companies who are looking to broaden their emerging markets footprint. Many of these companies may have limited constraints, armed with low cost of capital to reach the invisible segments, and also have significant technological capability to be more agile in product design. Perhaps, further inspiration for current providers of digital credit to respond to the issues raised here quickly.