In April 2021, a <a href="http://kenyalaw.org/kl/fileadmin/pdfdownloads/bills/2021/TheCentralBankofKenya_Amendment_Bill_2021.pdf" target="_blank" rel="noopener noreferrer">bill</a> that proposed licensing digital lenders was passed by the Kenyan parliament and is now pending approval from the national assembly. Among other things, this bill would require all digital lenders to submit product pricing to the Central Bank of Kenya for approval before launching, a move that seeks to lower predatory interest rates. Further, non-performing loans would be capped at <a href="https://www.businessdailyafrica.com/bd/economy/mobile-phone-lenders-risk-closure-in-cbk-bill-3376538" target="_blank" rel="noopener noreferrer">twice the amount of the initial loan defaulted</a>, which means lenders won’t be able to perpetually increase the amount to be paid back through late-payment fees.

Much has been <a href="https://www.bloomberg.com/news/features/2020-02-12/tech-startups-are-flooding-kenya-with-apps-offering-high-interest-loans" target="_blank" rel="noopener noreferrer">written</a> on the fintechs that have flooded the Kenyan market since 2016. FSD and CGAP published alarming <a href="https://www.cgap.org/blog/kenyas-digital-credit-revolution-five-years">evidence</a> in 2018 showing that in addition to a saturated digital lending market, an increasing number of digital borrowers in Kenya became over-indebted, which furthered them into <a href="https://www.microsave.net/2019/09/18/11310/" target="_blank" rel="noopener noreferrer">poverty traps</a>. Digital lenders such as OKash and Branch reportedly publicly shamed debtors by <a href="https://restofworld.org/2020/okash-microlending-public-shaming/" target="_blank" rel="noopener noreferrer">texting their friends, family, and colleagues</a>. Further, high-interest rates and non-transparent fees resulted in APR’s above <a href="https://qz.com/africa/1975202/kenya-prepares-to-crack-down-on-high-interest-loan-apps/" target="_blank" rel="noopener noreferrer">400 percent</a>, making it more difficult for some low-income borrowers to repay. In some instances, repayment was possible, yet it meant sacrificing other payments like food, medicine, or school fees. And finally, millions of borrowers were reported to credit bureaus for <a href="https://www.cgap.org/research/publication/consumer-protection-digital-credit" target="_blank" rel="noopener noreferrer">loans smaller than $10</a>.

During the COVID crisis, the Kenyan Central Bank issued a number of measures to ease the debt burden on borrowers, such as <a href="https://www.centralbank.go.ke/uploads/press_releases/850440997_Press%20Release%20-%20Credit%20Reference%20Bureau%20Regulations%20-%20April%202020.pdf" target="_blank" rel="noopener noreferrer">forbidding</a> unregulated mobile-based and credit-only digital lenders from reporting any late borrowers to credit bureaus. Although this helped ease debt stress on consumers during the crisis, this drove many digital lenders out of the market as levels of default skyrocketed, leaving <a href="https://www.theelephant.info/data-stories/2020/09/18/covid-19-regulatory-measures-could-widen-kenyas-financial-access-gap/" target="_blank" rel="noopener noreferrer">many Kenyan borrowers underserved</a>. The entire loan market in Kenya shrank due to COVID-19; today, these platforms lend around <a href="https://www.businessdailyafrica.com/bd/opinion-analysis/editorials/cbk-regulation-of-digital-lenders-is-long-overdue--3378386" target="_blank" rel="noopener noreferrer">2 billion shillings a month</a>, compared to 4 billion shillings in early 2020.

The proposed bill by the Central Bank of Kenya unfortunately will not address the issue of making digital credit both safe and accessible. The bill focuses on product pricing only, and it doesn’t address the underlying challenge of digital lending platforms: a weak credit assessment model. Such a model <a href="https://www.ted.com/talks/shivani_siroya_a_smart_loan_for_people_with_no_credit_history_yet?language=en" target="_blank" rel="noopener noreferrer">extracts large amounts of data from the borrower’s phone</a> and runs it through algorithms that approve or deny the loan. Many digital lenders mitigate the risk of a light-touch credit assessment with above-market APRs and hidden late payment fees, thus being able to generate profit and returns to their investors.

The primary problem is digital lenders do not measure the capacity of someone to repay, but their willingness to repay, and these are drastically different concepts. Willingness refers to the genuine disposition of a person to pay back their loan. Capacity, on the other hand, refers to the person’s ability to generate enough money in the future to pay back the loan without having to forgo essential expenses.
<blockquote class="pullquote--left">Digital lenders do not measure the capacity of someone to repay, but their willingness to repay and these are drastically different concepts.</blockquote>
For example, I might score very well on a digital risk assessment. My geo-trace shows I go to work every day, my call log shows I call my mom regularly, and my browsing history shows I do not engage in sports bets. These measurements indicate I am a responsible citizen who complies with her duties, suggesting that I have a high willingness to repay a loan. However, I might have astronomical medical expenses that the digital lender is unable to detect. Or I might be sending significant remittances to my family. Both of these relate to my repayment capacity and are measures that digital lending apps tend to ignore in favor of automated decision-making based on more readily available data.

By comparison, traditional banks run thorough credit risk assessments, sometimes so thorough that they are slow and expensive. These banks have credit committees and risk analysis departments that challenge relationship managers on the loan proposals they present. The result is that most people granted a loan have the means to pay it back. This method excludes the majority of the world’s population from the financial system, however, it also ensures that most people who are granted a consumer loan actually have the capacity to repay.

So where do we draw the line? How do we expand access to credit to low-income people and informal workers and also protect them from default? How can we measure their capacity to repay in a cheap, digital, and rapid manner? Should we prohibit alternative, digital, phone-based metrics that only assess someone’s willingness to repay?
<h2>A Possible Solution</h2>
The answer could be a measure in between. One idea is that the Central Bank of Kenya could only grant a license to digital lenders that incorporate the borrower’s capacity to repay in their credit assessment algorithms. This means, finding a way to measure, prove and integrate the person’s real income and expenses. Another option could be asking lenders to integrate proxies for repayment capacity. For example, mobile money records could be matched with the borrower's geolocation to determine where and why they are being paid and predict how stable his or her income is. Coupled with strong data protection measures, this and similar metrics could help curb the high default rate and loan-stacking among digital borrowers in Kenya without causing financial exclusion.

Further, as suggested in a <a href="https://centerforfinancialinclusion.org/making-digital-credit-truly-responsible/" target="_blank" rel="noopener noreferrer">publication produced by CFI</a>, the Central Bank of Kenya should withdraw a digital lender’s license upon surpassing a threshold percentage of non-performing loans as a share of the total loan portfolio. This would force the lenders to improve their algorithms and creatively design more capacity-measuring metrics. And finally, the CBK should explicitly require licensed digital lenders to cross-check an individual’s loan performance with each other before issuing further credit to prevent loan-stacking. Although the Digital Lenders Association of Kenya (DLAK) advocates for digital lenders to be able to receive and submit borrower information to credit bureaus, this practice has not addressed loan stacking in the past and only served to blacklist millions of borrowers for small amounts. Therefore, digital lenders should be allowed to view and report outstanding loans, yet with very limited power to blacklist a late borrower.
<blockquote class="blockquote">The CBK should explicitly require licensed digital lenders to cross-check an individual’s loan performance with each other before issuing further credit to prevent loan-stacking.</blockquote>
Kenya cannot go back to the old bank-driven model which financially excluded most of the population, yet Kenyans cannot keep paying the price for the financial experimentation of tech startups. Digital credit should be responsible, affordable, and inclusive. With this new bill, the Central Bank of Kenya is getting closer to achieving it. However, the root cause of the problem is the evaluation algorithm and the business model that stems from it. Without addressing this, little will change for Kenyan borrowers.

Digital Lending in Kenya: Willingness vs. Capacity to Repay

<em>Past crises have taught the microfinance sector a lot about weathering storms, and microfinance institutions (MFIs) are once again facing challenging times. This case study is part of a series that CFI, in partnership with the European Microfinance Platform (e-MFP) and the Mastercard Center for Inclusive Growth, is publishing to revisit tales of tough times and resiliency in five markets — <a href="https://centerforfinancialinclusion.org/weathering-the-storm-ii-a-case-study-of-viator-azerbaijan/" target="_blank" rel="noopener noreferrer">Azerbaijan</a>, Bosnia and Herzegovina, <a href="https://centerforfinancialinclusion.org/weathering-the-storm-ii-a-case-study-of-spandana/" target="_blank" rel="noopener noreferrer">India</a>, Nicaragua and <a href="https://centerforfinancialinclusion.org/weathering-the-storm-ii-vitas-palestine/" target="_blank" rel="noopener noreferrer">Palestine</a> — and discuss how MFIs, with the help of their investors and other stakeholders, emerged and thrived. The lessons learned from these cases will be compiled and examined in a forthcoming report, </em>Weathering the Storm II<em>, a follow-up to the first edition published in the aftermath of the global financial crisis a decade ago. The hope is that these lessons will be applicable to not only the COVID-19 response, but to future crisis responses as well.</em>

During the final months of 2008, as the world was entering what would be the worst economic crisis of the past half-century, Senad Sinanović, CEO of Partner Microcredit Foundation in Bosnia and Herzegovina, was contemplating the future.

A year earlier, he and his staff had celebrated Partner’s 20th anniversary. Partner was founded following the tragic war that marked the breakup of Yugoslavia, which had itself been assembled from the ashes of the Austro-Hungarian Empire 90 years earlier. It was in the country’s capital, Sarajevo, that WWI began, with the assassination of the Archduke Franz Ferdinand. On his frequent work visits to Sarajevo, Sinanović sometimes passed by the plaque marking the site of the “shot heard round the world,” along the way stepping on the Sarajevo Roses — red-painted shell marks on the pavement, remnants of the Bosnian war of the 1990s. In that corner of the world, history can seem omnipresent.

But it wasn’t history that was on Sinanović’s mind. He was worried about how the financial crisis would impact his clients, his institution, and the broader microfinance sector in the country. The path ahead concerned him greatly. The situation was unfolding against a backdrop of high liquidity in the sector. A strong period of growth of the main MFIs during the second half of the 2000s, as well as a new regulatory framework for microcredit, contributed to the high confidence of donors and funders, who responded by pouring large amounts of funding into the market.

In 2008, the tiny country of Bosnia and Herzegovina, with a population of 3.7 million, was the second biggest destination worldwide, behind Peru, for <a href="https://www.cgap.org/sites/default/files/CGAP-Focus-Note-Foreign-Capital-Investment-in-Microfinance-Reassessing-Financial-and-Social-Returns-May-2011.pdf" target="_blank" rel="noopener noreferrer">foreign capital investment</a> in the microfinance sector. In that market, Partner was (and still is) one of its leading MFIs, with the third largest by gross loan portfolio at about 181 million convertible marks (abbreviated KM), or about USD$106 million, and the second largest in number of active borrowers, at 63,500.

High liquidity may be a blessing during growth periods, but it quickly becomes a curse when loan demand contracts and all that cash sits in a bank, yielding no income. The deep recession in Bosnia brought about by the global financial crisis strongly affected the micro and small enterprises in the country, resulting in less appetite for investment, and thus for the business loans provided by the microcredit sector.
<blockquote>High liquidity may be a blessing during growth periods, but it quickly becomes a curse when loan demand contracts and cash sits in a bank, yielding no income.</blockquote>
Those same challenges also lowered clients’ ability to repay their existing loans. In a context of intense competition between MFIs and widespread multiple borrowing — which was difficult to trace since the use of credit bureau data was still incipient — this predictably resulted in severe loan delinquency problems and credit losses across all MFIs. The poor lending standards of several MFIs also undermined the sector’s reputation, further legitimizing non-repayment of loans even beyond what might have been expected from the economic downturn alone.
<h2>Dealing With High Liquidity</h2>
Partner had, by the end of 2008, a total debt of 156 million KM, broken down into 10 outstanding short-term loans with local banks and 23 long-term loans from foreign social and development investors. While the overwhelming majority of these were market-rate loans, Partner also had subsidized loans, including a 6 million euro loan from a bilateral public funder.

<img class="alignleft wp-image-41167" src="https://content.centerforfinancialinclusion.org/wp-content/uploads/sites/2/2021/01/Chart-debt-in-KM-4.png" alt="bar graph debt" width="700" height="389" />Some of the loans had just been disbursed when the crisis began to unfold, leading to a situation where Partner was sitting on a pile of money that it could not lend out, and thus could not generate income, even as the interest due on the loans continued to accrue.

To limit interest losses, especially on its more recent and expensive loans, Sinanović tried to give the money back, asking to prepay the loans ahead of schedule. However, this was not welcomed by all investors, and some needed to be persuaded to accept the money and terminate the contracts without penalties. This process included a meeting in April 2009 with lenders at the Microfinance Centre (MFC) conference in Belgrade, organized by a group of Bosnian MFIs, including Partner. Facing the reluctance of some investors to accept early loan prepayment, one of the Bosnian CEOs questioned if their behavior was consistent with social investing, which helped change investors’ minds. During the period of crisis, and in the following years, Partner’s short- and long-term debt fell significantly. By the end of 2011, its total debt was down 61 percent from its peak in 2008.
<h2>Getting Ahead of Events</h2>
While reducing excess liquidity solved a part of Partner’s problems, the MFI was still facing strong, serious challenges in its loan portfolio and the consequences of escalating credit and market risks.

<img class="alignright size-full wp-image-41142" src="https://content.centerforfinancialinclusion.org/wp-content/uploads/sites/2/2021/01/Chart-glp-delinquency-partner.png" alt="graph" width="600" height="320" />During 2009 and 2010, Partner’s portfolio contracted by nearly 50 percent off its 2008 peak, and while it has been recovering steadily since then, as of 2019, its portfolio remains 25 percent smaller than it was over a decade ago, at 137 million KM ($78 million).

<img class="alignright size-full wp-image-41191" src="https://content.centerforfinancialinclusion.org/wp-content/uploads/sites/2/2021/01/Chart-write-offs-partner-V2.png" alt="chart" width="600" height="266" />Beginning in 2008, delinquency levels grew rapidly, peaking at 11.5 percent in 2010. Partner also took an aggressive approach to writing off loans it saw as non-recoverable. Between 2009 and 2011, the MFI wrote off 11.4 percent of its 2008 gross loan portfolio (GLP). While high, these credit losses were modest in the context of the Bosnian microfinance crisis. Three of Partner’s major competitors experienced cumulative write-offs of 25 percent or more of their peak 2008 portfolio (according to the authors' calculation using <a href="https://databank.worldbank.org/source/mix-market" target="_blank" rel="noopener noreferrer">MIX Market</a> data).

Nonetheless, Partner’s portfolio quality was worrying, and during the early months of the crisis, Sinanović knew already that Partner would breach many of its debt covenants with its lenders. Together with Partner’s board of directors, Sinanović decided to get ahead of events and provide lenders all the information available on the context of the crisis, the reputation issues affecting the sector, and the exact situation of the MFI. For this, Sinanović and his staff prepared a detailed, 13-page memorandum outlining the impact of the crisis on Partner, its clients, and the Bosnian microfinance market, as well as Partner’s response up to that point and planned next steps. The memo also included extensive monthly data and ratios pertaining to Partner’s portfolio and financial situation. This document was sent to all 17 creditors in April 2009, when the crisis was still in its early phase.
<blockquote class="pullquote--left">Sinanović and his staff prepared a detailed, 13-page memorandum outlining the impact of the crisis.</blockquote>
In this way, Partner’s transparency helped gain lenders’ confidence and, at the same time, effectively created the reporting template for all individual creditors. This early transparency helped Partner avoid being flooded with multiple and diverse requests for information by lenders and gave Sinanović and his team the space to focus on containing repayment problems in its portfolio.

Midway through the crisis, after extensive conversations with like-minded MFIs in the country and with support of outside stakeholders, Partner went further. In 2010, together with two other MFIs, EKI and Mi-Bospo, Partner created U-Plusu. This non-profit financial management advisory center aimed to tackle client over-indebtedness and improve the public image of the institution and the sector by providing financial education and mediation services between clients and financial institutions, especially in cases of multiple borrowing.

Despite the serious impact from the crisis, with credit losses accompanied by steep drops in lending and profitability (ROE decreased from 24 percent in 2008 to -5 percent in 2009), Partner managed to keep the situation under control throughout, and its solvency was never at risk. In fact, despite the large provisions and eventual write-offs, Partner’s equity only slightly decreased during the crisis period (from 43 million KM to 41 million KM).
<blockquote>Partner's solvency was never at risk and its equity only decreased slightly.</blockquote>
Partner’s ability to weather the storm was closely linked to a process of foresight and preparation led by Sinanović and the MFI’s directors. It started with swift adaptation to a significant decrease in loan demand, both in terms of credit offer and operational structure, and an aggressive strategy regarding write-offs, while getting rid of excessive liquidity and being proactive and transparent in its communications with creditors. All this helped Partner ready itself for what would be a sustainable — albeit smaller — future.

<em>What are some dos and don’ts and key success factors that the microfinance sector can learn from the Partner case? CFI’s forthcoming report, </em>Weathering the Storm II<em>, will draw on lessons from Partner and cases from microfinance institutions in four other markets: </em><a href="https://centerforfinancialinclusion.org/weathering-the-storm-ii-a-case-study-of-viator-azerbaijan/" target="_blank" rel="noopener noreferrer"><em>Azerbaijan</em></a><em>, </em><a href="https://centerforfinancialinclusion.org/weathering-the-storm-ii-a-case-study-of-spandana/" target="_blank" rel="noopener noreferrer"><em>India</em></a><em>, </em><a href="https://centerforfinancialinclusion.org/weathering-the-storm-ii-vitas-palestine/" target="_blank" rel="noopener noreferrer"><em>Palestine</em></a><em> and Nicaragua. See also the <a href="https://centerforfinancialinclusion.org/weathering-the-storm-hazards-beacons-and-life-rafts-lessons-in-microfinance-crisis-survival-from-those-who-have-been-there/">original Weathering the Storm</a> report from 2011. </em>

Weathering the Storm II: A Case Study of Partner

As the pandemic threatens the survival of many financial institutions, the temptation to trade client well-being for the financial health of the institution is ever present. While profit maximization and predatory lending behaviors might lead to bigger market shares and profits in the short run, they will ultimately destroy value in the long run. Even more so during these challenging times, financial institutions should make a conscious choice to put client protection at the center of their response by taking a long-term view that will ensure future customer loyalty and a faster recovery.

Just as a board of directors looks out for shareholders, at <a href="https://mahamfi.com/" target="_blank" rel="noopener noreferrer">Maha</a> we believe it is our obligation to look out for the interests of the clients. The process of Smart Campaign certification (we are now proud to be Smart certified) has encouraged every staff member across Maha to champion consumer protection so that it becomes instinctive for us when making decisions or interacting with clients.

The current situation in Myanmar has been a test of this approach. We are an agri-focused institution; 90 percent of our clients are smallholder farmers. Last spring, we wrote about how we had to <a href="https://centerforfinancialinclusion.org/diary-of-a-myanmar-based-agri-focused-fsp-responding-to-the-covid-19-crisis/" target="_blank" rel="noopener noreferrer">adapt to regulatory and government directives</a> during the pandemic’s early stages. Here we present several measures we’ve taken over the last few months to keep the well-being of our clients and the organization at the center of our decision-making process.
<h2>Cash Discount</h2>
One of the first measures we took was to offer a cash discount to customers. This achieved a two-fold purpose of not only encouraging repayments but also of providing financial support to our clients during these difficult times. This, at a time when many lending institutions were slowing down disbursements, was received positively by our clients as there were no strings attached. Moreover, we maintained our loan amount, which is the second highest in the country for long-term customers. This served as a source of relief and allowed our farmers to continue with their cropping cycle as usual.
<h2>Fair and Respectful Treatment of Clients</h2>
This principle became our North Star as we have seen delinquency go up and the need to maintain optimal collections to continue operations also becomes paramount. To ensure that we all adhere to our code of ethics, we undertook additional modules of training with specific guidelines on client interaction during the pandemic. This involved awareness of verbal and non-verbal cues that may be perceived as pressure to repay by our clients.
However, this alone was not enough. We also had to make sure that we were not incentivizing aggressive collections in any way. We addressed this by altering our incentive scheme to place a greater emphasis on preventing over-indebtedness and keeping our portfolio healthy. We also modified the incentive scheme eligibility criteria by increasing the portfolio quality threshold so that it reflects the reality of increased delinquency.
<blockquote class="pullquote--right">Maha made sure it was not incentivizing aggressive collections in any way.</blockquote>
Finally, we have put together a special delinquency management process with a designated task force to address the dynamic situation created by COVID-19. Our efforts in this direction were further affirmed by the Financial Regulatory Department (FRD), our regulator has issued a directive (No. AA – 1/6 [785/2020] dated 13 October 2020) and guidelines to ensure that institutions do not engage in forced collections. As a customer-centric, triple-bottom-line institution, we welcome these measures and are committed to finding solutions to address the needs of our clients during these challenging times.
<h2>Customer-Centricity</h2>
Our customer-centric approach during this pandemic has taken a two-fold approach of establishing a strong and effective feedback loop with clients, coupled with education on pressing issues. Soon after the onset of the pandemic, we conducted a client satisfaction survey which was followed by a COVID-19 impact survey, both of which allowed us to stay attuned to the evolving circumstances and needs of our clients.

We addressed a variety of concerns from income to food security and mental health. We learned that clients expressed greater concern about the economic impact of the crisis compared to health issues, and some began to eat less to save more to cope with the uncertainty. These surveys have provided us with actionable intelligence to ramp up digital services to overcome movement restrictions, provide faster turnaround times, and reschedule where applicable. We are now working on rescheduling on a case-by-case basis and are about to launch cashless repayments using mobile money agents.

Our second approach, which included education, was linked to a growing concern about multiple lending and over-indebtedness. The inclination to borrow as much as possible in times of uncertainty is hardly a surprising phenomenon when those we serve are unlikely to have savings that they can rely on. Through a combination of SMS alerts and pamphlets, we have educated our clients on the dangers of over-indebtedness and have given them advice on how they can optimally manage their finances.
<blockquote>Surveys have provided us with actionable intelligence to ramp up digital services to overcome movement restrictions, provide faster turnaround times, and reschedule where applicable.</blockquote>
Finally, we undertook a COVID-19 awareness campaign to help clients protect themselves, be apprised of symptoms they should look out for, and be informed by guidelines on how to proceed in case of a suspected infection. Through a combination of feedback and education, our aim has been not only to protect our clients, but to empower them to make the right decisions that will allow that to preserve their physical and financial health until the end of the crisis.

A medley of these measures has allowed us to stay true to our mission to create a long-term sustainable impact on the lives of our rural farming communities.

How Consumer Protection Has Driven Maha’s COVID-19 Response

<em>Past crises have taught the microfinance sector a lot about weathering storms. Microfinance institutions (MFIs) are once again facing challenging times. This case study is part of a series that CFI, in partnership with the European Microfinance Platform (e-MFP) and the Mastercard Center for Inclusive Growth, is publishing to (re)visit tales of tough times and resiliency in five markets – <a href="https://centerforfinancialinclusion.org/weathering-the-storm-ii-a-case-study-of-viator-azerbaijan/" target="_blank" rel="noopener noreferrer">Azerbaijan</a>, Bosnia and Herzegovina, India, Nicaragua and <a href="https://centerforfinancialinclusion.org/weathering-the-storm-ii-vitas-palestine/" target="_blank" rel="noopener noreferrer">Palestine</a> – and discuss how MFIs, with the help of their investors and other stakeholders, emerged and thrived. The lessons learned from these cases will be compiled and examined in a forthcoming report, Weathering the Storm II, a follow up to the <a href="https://centerforfinancialinclusion.org/weathering-the-storm-hazards-beacons-and-life-rafts-lessons-in-microfinance-crisis-survival-from-those-who-have-been-there/" target="_blank" rel="noopener noreferrer">first edition</a> published in the aftermath of the global financial crisis a decade ago. The hope is that these lessons will be applicable to not only the COVID-19 response, but to future crisis responses as well.</em>

Spandana started in 1998 as a microcredit program of an NGO. It quickly became one of the bellwethers of the country’s microfinance industry, offering small group loans to predominately low-income women without the need for collateral. When Spandana was incorporated as a non-bank financial company/microfinance institution (NBFC-MFI) in 2003, it was the largest microfinance institution in India and the sixth largest in the world. In the early 2000s, Spandana was growing rapidly and began exploring a path to an initial public offering (IPO).

The state of Andhra Pradesh (AP) had become one of the most competitive microfinance markets in India during this time. As more commercial MFIs grew, they competed with the state government’s Self-Help Group-Bank Linkage (SHG) program. The SHGs had access to capital from the banking system and worked with millions of underserved women by helping them save small sums and take out loans.

The AP government started to become uneasy with the outsized impact and influence of commercial MFIs, however. Increased competition led to excessive lending, with many clients taking out multiple loans from both SHGs and commercial MFIs. Average household debt in AP rose to about INR 65,000 compared to a national average of about INR 70,001. The MFIs were accused of harassing customers for repayment. The suicide rate spiked, and the state government began attributing some of these suicides to excessive lending by the MFIs and coercive loan recovery practices.
<blockquote>The Andhra Pradesh government started to become uneasy with the outsized impact and influence of commercial MFIs.</blockquote>
In order to rein in the alleged coercive recovery practices of the commercial MFIs, the state government passed the AP Microfinance Institutions (Regulation of Money Lending) Act in October 2010. The ordinance barred MFIs from collecting payments at certain locations, such as a borrower's home or place of work. The regulatory authority also set interest rate caps and mandated stringent reporting guidelines.

<img class="alignright wp-image-40319" src="https://content.centerforfinancialinclusion.org/wp-content/uploads/sites/2/2020/11/Spandana-Portfolio-Distribution-Chart-V3-1024x639.png" alt="" width="450" height="281" />Clients misconstrued the ordinance to justify non-repayment of loans owed to the MFIs with no serious repercussions. Within a month, the loan repayment rate had dropped from 99.89 percent to 1 percent. An estimated INR 70 billion in loans in the state, from about 6.25 million accounts, had come under stress. This led to severe cash flow problems for the MFIs in the region. In the end, the ordinance caused some MFIs in the state to close and declare bankruptcy. For Spandana, even though it had sufficient capital adequacy (with equity of INR 4.85 billion), the unfolding crisis meant severe financial stress and cash flow problems.

At the onset of the crisis, loans in AP accounted for about half of Spandana's portfolio. In addition to its customers, the livelihoods of the firm’s employees were also at stake: Spandana employed 7000 in AP and had 850 branches operating there.

After the shock of the ordinance rippled through the microfinance ecosystem, Spandana felt it had no choice but to take the case to the court. While it was good news that their case eventually reached the Supreme Court, it meant a long wait, and Spandana’s management was forced to suspend operations in AP and scrap their IPO plans while the court heard their case. Knowing it couldn’t depend on the legal challenge alone, however, Spandana leadership triaged the most pressing challenges and made some difficult business decisions.
<h2>Hard Solutions for A Long Recovery</h2>
The senior management team quickly recognized that liquidity, crucial for ensuring the company could continue operations, was the top challenge. But for Spandana, additional liquidity in the form of financing was hard to come by as it had taken on debt from 48 lenders to fuel its growth.

<img class="alignleft wp-image-40320" src="https://content.centerforfinancialinclusion.org/wp-content/uploads/sites/2/2020/11/Lenders-Chart-V3-1024x711.png" alt="pie chart" width="450" height="312" />The team ultimately felt that a corporate debt restructuring (CDR) would be appropriate to get needed liquidity and avoid default. ICICI Bank and SIDBI, Spandana's largest lenders, agreed with the management team's assessment that Spandana needed a CDR. The team needed to convince the Reserve Bank of India (RBI), however, because it did not allow such a facility for NBFCs. Spandana's executive team, along with ICICI and SIDBI, began efforts to persuade the RBI to authorize debt of NBFCs as eligible for a CDR. At the same time, the management team held discussions with its investors to gather internal support for a CDR, pending RBI approval.

In 2011, after months of dialogue with the RBI, Spandana, along with other NBFCs in AP, finally got what they wanted: authorization to proceed with a CDR in accordance with guidelines established by the new policy. The RBI also established rules, which played an important role in stabilizing the regulatory environment on issues related to operational process, customer protection, and governance. It also created a separate class of institutions for NBFC-MFIs for regulatory purposes.

ICICI and SIDBI managed to persuade most lenders to sign on to the CDR package by emphasizing the increased chance of recovery over time with improved ground-level conditions, although some lenders did not agree to the CDR and were left out. In September 2011 (see timeline graphic below) Spandana’s investors signed the CDR, which would restructure their INR 21.46 billion in loans outstanding to address its exposure in AP and assist with liquidity challenges. The CDR had two components:
<h3>1. Optionally Convertible Note (OCN)</h3>
INR 10 billion (46 percent) of the outstanding loan value, an amount equivalent to AP portfolio that was deemed irrecoverable, was restructured into a convertible quasi-equity instrument. A redemption premium of 12 percent per annum was payable at redemption. The lenders also had the option to convert these instruments into equity shares of the company, an option Spandana hoped investors would exercise.
<h3>2. Term Loan</h3>
The remaining INR 11.5 billion (54 percent) was bundled into a 72-month term loan repayable in monthly installments at 12 percent interest from April 2012. The term loan was secured by a pledge of 7.27 million Spandana shares owned by its founder, Padmaja Reddy.
<h2>Leaner and Stronger Operations</h2>
While the CDR resolved the initial liquidity issues keeping Spandana from defaulting, many other business and operational challenges had to be dealt with in order to ensure long-term survival. The first, most immediate challenge was Spandana's increasing operational costs coupled with declining revenue. After an exhaustive analysis of its operational costs, the team decided to reduce its number branches and staff.

The next challenge was to establish strong practices related to customer experience and engagement. This included organizing institution-wide staff trainings on appropriate field behavior and client communications. To further improve field behavior, the staff remuneration structure was changed so that 70 percent of staff salaries were fixed, as opposed to 30 percent before the crisis. The goal of this was to encourage staff focus on portfolio quality instead of growth.
<blockquote class="pullquote--right">Staff members were encouraged to focus on portfolio quality instead of growth.</blockquote>
In 2012, after waiting almost two years, the Supreme Court ruled that Spandana could restart lending and recovery operations in the state. This decision restored Spandana’s recovery efforts and it managed to collect INR 10 billion between FY 2011 and FY 2017. With collections resuming in AP, and the new liquidity provided by the CDR, Spandana decided to expand its portfolio to other states to counter perceived overexposure to AP. By deploying capital in other states, Spandana managed to lower its exposure in Andhra Pradesh to 3.1 percent of its active portfolio in 2017, significantly lower than the pre-crisis level of 51 percent.

Spandana also needed to show it was on track operationally. In FY 2014, Spandana reported disbursing INR 16.67 billion in new loans. The improved collection rate and business performance gave confidence to the CDR lenders, which helped Spandana persuade them to defer CDR payments for a period of two years, from January 2014 to December 2015. This agreement allowed Spandana to continue using the cash from collections to reinvest in the expansion of lending operations. ICICI Bank also stepped up to provide an INR 11.5 billion credit facility to boost portfolio growth outside AP. As a result of these efforts, Spandana was able to strengthen its financial performance and condition and begin servicing the CDR when initial payments came due in 2016.
<h2>Profitability and A Strong New Ally</h2>
The shift in strategy, resumed collections in AP, and operational changes allowed Spandana to become profitable starting in FY 2014 (2013-14) after three years of losses (see graphs below). In FY 2016, Spandana reported a profit of INR 2.45 billion. Moreover, its capital adequacy ratio, which was negative the prior two years, turned positive in FY 2017.

<img class="size-full wp-image-40382 aligncenter" src="https://content.centerforfinancialinclusion.org/wp-content/uploads/sites/2/2020/11/Profit-Tax-Chart-V6.png" alt="" width="750" height="458" />

<img class="aligncenter size-full wp-image-40383" src="https://content.centerforfinancialinclusion.org/wp-content/uploads/sites/2/2020/11/Capital-Adequacy-Chart-V5.png" alt="graph" width="750" height="399" />

Although Spandana attempted to fulfill the CDR obligations, there were times when collections and revenue were not adequate to cover payments. Therefore, in 2016, the management began scouting for investors to obtain new funding and buy out the CDR lenders who did not intend to convert their investment into equity. While Spandana continued to negotiate the payoff of the OCN, time was running out fast to find new equity investors. In 2017, Kedara Capital, recognizing Spandana's long-term value, invested by buying out the remaining portion of the OCN. Spandana was also able to get a consortium of banks to provide a loan of INR 11 billion to pay off the outstanding term loan of the CDR. Following these moves, Spandana exited the CDR package, which assisted in improving its credit rating

<img class="aligncenter size-full wp-image-40325" src="https://content.centerforfinancialinclusion.org/wp-content/uploads/sites/2/2020/11/Spandana-Timeline-V2.png" alt="spandana timeline" width="1500" height="613" />

By 2019, Kedara Capital gradually increased its investment in Spandana to 59.1 percent. As a majority shareholder, Kedara took an active role to help Spandana consolidate the number of lenders and increase the availability of capital at lower cost. With the support of Kedara, the number of lenders was reduced to five, and Spandana was able to obtain new financing for business expansion. Kedara also advised the company to improve its governance structure by bringing in industry experts to serve as independent directors. This rebuild fueled Spandana’s operating and profit margins while enabling the upgrade of its credit ratings.
<blockquote class="pullquote--right">Kedara advised Spandana to improve its governance structure by bringing in industry experts to serve as independent directors.</blockquote>
Finally, 10 years after the AP crisis, Spandana came full circle when it successfully launched its IPO in 2019.  It went well: the company’s share price rose more than 33 percent between August 2019 and late February 2020. Then, COVID hit…

<em>What are some of the dos and don’ts and key success factors that the microfinance sector can learn from the Spandana case? CFI’s forthcoming report, </em>Weathering the Storm II<em>, will draw on lessons from Spandana and cases from microfinance institutions in four other markets – <a href="https://centerforfinancialinclusion.org/weathering-the-storm-ii-a-case-study-of-viator-azerbaijan/" target="_blank" rel="noopener noreferrer">Azerbaijan</a>, Bosnia, Palestine and Nicaragua. See the original Weathering the Storm report from 2011 <a href="https://centerforfinancialinclusion.org/weathering-the-storm-hazards-beacons-and-life-rafts-lessons-in-microfinance-crisis-survival-from-those-who-have-been-there/" target="_blank" rel="noopener noreferrer">here</a>.
</em>

<em>The author is extremely grateful to N.K Maini, ex-Deputy Managing Director of SIDBI, Gourisankar Gollapudi, CEO of Manaveeya Development and Finance Limited, Nitin Agarwal (former CEO of Spandana between 2010 and 2014) Prakash Kumar, CGM, SIDBI, for agreeing to be interviewed about the Spandana crisis and revival. We would also like to thank Tanwi Kumari for her invaluable research assistance on this project. This case would not be complete without their contributions.</em>

Weathering the Storm II: A Case Study of Spandana

Recent research on the <a href="https://www.centerforfinancialinclusion.org/making-digital-credit-truly-responsible">state of the digital consumer credit market in Kenya</a> has documented breakneck growth in mobile lenders and alarming levels of defaults and delinquency. These findings, coupled with <a href="https://www.bloomberg.com/news/features/2020-02-12/tech-startups-are-flooding-kenya-with-apps-offering-high-interest-loans">anecdotal reports</a> of aggressive sales tactics, abusive debt collections, and unacceptable levels of debt stress, raise an enormous red flag regarding digital consumer credit’s potential for financial inclusion.

The promise of digital credit is to make people with no documented financial history visible to the formal financial system, helping low-income people gain access to loans and other financial products. Microcredit started out with a similar promise to help people move out of poverty, but the microfinance industry learned the hard way that good intentions are insufficient. After microcredit-fueled, <a href="https://www.cgap.org/sites/default/files/CGAP-Focus-Note-Growth-and-Vulnerabilities-in-Microfinance-Feb-2010.pdf">overindebtedness crises</a> spiraled out of control, the industry introduced protective measures and formal regulation followed in many countries. The red flags appearing in Kenya’s digital credit market are familiar, but a host of new players beyond traditional banks and microfinance providers may not recognize the signs of a looming crisis.
<h2>New Entrants, New Credit Models</h2>
New tech players are flooding into markets like Kenya to offer scalable models for faster and more accurate loan products backed by big data. Mobile app-based lenders use nontraditional data to provide near-instant credit decisions for loans ranging from the equivalent of $5 to $100. The algorithms at the core of these products rely on unverified, self-reported user information and data scraped from users’ mobile phones, including call logs, contacts, location, social media activity, and text messages. An inherent flaw in these models is that they are built on data reflecting a consumer’s willingness to repay rather than their ability to repay. This is a crucial distinction representing the difference between a client that is willing to skip meals or borrow from other lenders to repay the original loan and a client that can afford the loan without experiencing such debt stress. Repayment rates may appear acceptable, but this flaw in the model masks a brewing overindebtedness crisis as repayment rates don’t account for loan stacking or abusive debt collection practices.

&nbsp;

It’s Time to Protect Kenyans from a Digital Lending Laboratory

In the past few months, questions have been raised about the quality of microfinance debt collection practices in Cambodia. A damning recent <a href="http://www.licadho-cambodia.org/reports.php?perm=228">report</a> by LICADHO, a Cambodian human rights organization, concluded that MFIs in Cambodia have relied on “inadequate government regulation and the widespread complicity of local authorities” to unethically and illegally force indebted Cambodian borrowers to sell their land titles in order to secure repayment. Borrowers, unaware that land seizures are illegal, are intimidated into doing so. Interviewees in the report also indicated other lender abuses, including child labor, debt-driven migration and food insecurity – all because they couldn’t pay loans on time. The report, which the Center for Financial Inclusion recommends reading, raises serious concerns about human rights and consumer protection.

CFI has been an advocate of consumer protection in Cambodia for <a href="https://www.cgap.org/blog/supporting-client-protection-cambodia">many years</a>, working with a variety of stakeholders in the country, including donors, financial service providers, clients and the government. We believe that using threats as a means to extract repayment is unacceptable, and the allegations from LICADHO should be taken seriously and further investigated. Responsible practices should be reinforced by providers as needed.
<blockquote>We believe that using threats as a means to extract repayment is unacceptable.</blockquote>
However, as the report itself and the Cambodia Microfinance Association (CMA) <a href="https://www.construction-property.com/lichado-report-selective-and-misleading-says-cma/">point out</a>, the results need contextualization. The sample size is very small – only 28 interviews were conducted in four provinces and Phnom Penh – and is not meant to be statistically representative of Cambodia or all MFI clients. All interviews were conducted in a very short timeframe: spring 2019. Are a small number of providers concerned, or is the report surfacing issues that indicate an existing (and possibly increasing) general crisis amongst MFI providers? While the issues raised in the report merit attention, even if they affect a proportionally small number of clients, it is important to understand the scope of the problem in order to determine how to adequately address it.

The <a href="http://smartcampaign.org/about/smart-microfinance-and-the-client-protection-principles">Consumer Protection Principles</a> contain strict guidelines that deter providers from violating borrowers’ human rights. Consumer Protection Principle 5, which concerns the fair and respectful treatment of clients, strictly prohibits Smart-certified financial service providers from using abusive language, using physical force, limiting physical freedom, shouting at the client, entering the client’s home uninvited, publicly humiliating the client, violating the client’s right to privacy, mistreating a client based on any protected groups, using intimidation or threats, sexual or moral harassment. Guideline 5.3.3 explicitly states that “the provider staff may not force clients to sell their own collateral to pay off their debt.”

But it’s not about just setting principles and hoping providers abide by them. The <a href="http://smartcampaign.org/certification">Smart Certification</a> process requires financial service providers to demonstrate their adherence to the Client Protection Principles and corresponding standards. It represents a rigorous analysis of an institution’s policies, systems and practices, carried out by licensed third-party organizations. Recognizing that organizations, regulations and product offerings evolve, our 115 certified-organizations worldwide are required to be recertified every four years, with a two-year check-in, and a required recertification if the organization goes through material change. Certification is a measure of whether an institution has adequate systems in place to prevent client harm, ensuring that harm isn’t occurring, and mitigate it if it is. The Cambodian microfinance sector, with support from CMA, has worked hard over the years to improve practices in order to meet the rigorous bar set by Smart Certification. Eight Cambodian institutions are currently Smart-certified: LOLC, Acleda Bank Plc, AMK, Hattha Kaksekar Ltd., Amret Microfinance, Sathapana Bank, VisionFund Cambodia, and Thaneakea Phum.

Through the assessment and certification process, widespread client abuses come to light and the institution is given recommendations on how to address them. On the other hand, one-off poor and abusive decisions on the part of selected individuals may not surface. This is why complementary research of alleged abuse, and the presence of well-functioning recourse mechanisms for clients are critical.
<h2>CFI's Role in Cambodian Consumer Protection</h2>
CFI started its engagement with the microfinance sector in Cambodia in 2012, a time when the Cambodian market, a victim of its own success, was growing at a pace seen by many as unsustainable: between 2004 and 2014 the growth in the average household loan size <a href="https://cma-network.org/files/OIDWORKSHOP/MIMOSA Circular Cambodia Jun 2016.pdf">outpaced growth</a> in average client income by a factor of four. CFI convened key funders of the main MFIs and encouraged them to embrace Smart certification as part of their screening and due diligence process to ensure that providers had adequate policies and practices in place to prevent over indebtedness and poor client treatment. In the years that followed, and with generous support from the Agence Francaise de Développement (AFD), CFI supported an ambitious consumer protection program aimed at developing the country’s credit bureau, strengthening the capacity of the Cambodia Microfinance Association (CMA) and improving practices of the main financial service providers (FSPs) to the poor in the country.

FSP practices drastically improved as part of this work. Collectively, the eight Smart Certified institutions in Cambodia serve 1.6 million clients. This is an incredible achievement for the sector, as these clients are served by institutions that have committed (and demonstrated) that they have put in place systems and processes to protect their rights and treatment. Preventing over indebtedness is complex, especially in the context of fast-growing markets and an environment where lenders are not always required to report to the credit bureau.
<blockquote>The eight Smart Certified institutions in Cambodia serve 1.6 million clients.</blockquote>
<h2>Lending Guidelines</h2>
As concerns of over indebtedness have continued to <a href="https://mimosaindex.org/inexorable-growth-in-cambodia-like-a-rolling-stone-2/">rise over the years</a>, concerned players decided to go a step further and understand better the underpinnings of growth in the Cambodian market, as well as ways to ensure a responsible growth. Since 2016, the <a href="https://cma-network.org/">CMA</a>, <a href="http://www.incofin.com">Incofin</a>, <a href="https://mimosaindex.org/">MIMOSA</a>, the Credit Bureau of Cambodia, the Smart Campaign at CFI, and several other stakeholders have been developing and refining the CMA Lending Guidelines. The <a href="https://www.microcapital.org/special-report-a-model-from-cambodia-for-preventing-overheating-not-just-multiple-lending-to-be-presented-at-european-microfinance-week-november-14-16-2018/">project</a> was funded by Incofin, <a href="https://www.proparco.fr/en">PROPARCO</a>, BIO, <a href="https://www.fmo.nl/">FMO</a> and <a href="https://www.ada-microfinance.org/en">ADA</a>.

The Lending Guidelines, published in 2016 (overview <a href="http://www.e-mfp.eu/sites/default/files/resources/2018/11/Preventing overindebtedness in Cambodia_all speakers.pdf">here</a>), were developed because the industry in 2015 was growing at an average of 25 percent per year, even as the number of loans remained unchanged at 2.3 million. This meant that the same clients were taking more debt when their loans were renewed, even though their economic activities did not justify it. The average loan size had almost doubled, growing from close to $1,700 to a little over $3,000 with loan maturity of four to five years (the GDP per capita in 2017 stood at around $1,400). The Lending Guidelines have identified excessive and reckless refinancing as a key concern area for the lending sector, and recommend maximum thresholds for refinancing, above which lenders are bound to more scrutiny. They include a mix of indicators highly correlated to over indebtedness, such as multiple borrowing, loan to income ratio, and refinancing rates.
<blockquote>The Lending Guidelines have identified excessive and reckless refinancing as a key concern area for the lending sector.</blockquote>
The FSPs that have endorsed the lending guidelines have adapted their credit their underwriting policies and enhancing their risk management practices. The National Bank of Cambodia (NBC) has been supportive of the Lending Guidelines and has made public statements on calling FSPs to adopt them. The Central Bank of Cambodia issues a monthly dashboard that shows the FSPs level of compliance with the Lending Guidelines. The Lending Guidelines have been fully integrated into the Smart Certification process and not abiding to the Lending Guidelines can be one of the causes for not having a Certification renewal. The Lending Guidelines are reviewed to ensure that they are meaningful in curbing the risk of over-indebtedness. The Lending Guidelines are an example of a market defining precise recommendations to address a specific issue occurring in a market (here, excessive refinancing). As other issues surface and are demonstrated (i.e., intimidation and illegal land seizure), additional monitoring and mitigation strategies can be put in place at the market level to address systemic issues and complement the individual work of responsible providers.
<h2>Next Steps: Improving Regulation and Learning From Clients</h2>
I recently traveled to Phnom Penh to attend a closed meeting of regulators, hosted by the NBC and supported by Asian Development Bank, to discuss how authorities can improve oversight. There were a few key takeaways from this. Even though the NBC is actively working on draft consumer protection regulation, current financial consumer protection regulations are weak. The National Bank of Cambodia is dependent on the CMA to mitigate the risks that are looming over the sector. There is, however, an initiative in an initial phase to create a registry of collaterals, assets, and fixed values. Overall, it’s encouraging to see that there’s consensus on the necessity for more sensitization of regulators on consumer protection, as the national financial inclusion strategy is more heavily focused on credit report sharing. The CFI is excited to work with the NBC, drawing from the <a href="https://www.smartcampaign.org/tools-a-resources/1210-handbook-on-consumer-protection-for-financial-inclusion">Handbook on Consumer Protection for Financial Inclusion</a> (recently updated to reflect the risks to consumers in a digital financial world) to improve the Cambodian regulatory framework.
<blockquote>It’s encouraging to see that there’s consensus on the necessity for more sensitization of regulators on consumer protection.</blockquote>
In addition to improving the regulatory framework, we must have better and more frequent ways to hear from clients directly.

With this in mind, we ask: is collateralized debt seizures a troubling and growing trend, or was the LICADHO study reflecting isolated incidences of mistreatment? We hope that a new study initiated by CFI will help shed light on the issue. The study, known as Client Voice, uses an interactive voice response (IVR) approach. Three Smart Certified FSPs – AMK, Maxima and HKL – will participate, and 500 to 1,000 clients from each institution will be surveyed. Institutions that are at the stage of transforming to digital product offerings – such as AMK – are looking to adopt new and better ways to gather ongoing feedback from clients to improve their product design and delivery and are keen to test the IVR system to that effect. The study will be completed by December 2019, and the results will be published by January 2020.

Land Seizures and Reported Abuses in Cambodia: CFI Responds

Digital credit has emerged as a new and profitable service offering that has great potential to increase financial inclusion. Yet, if not carefully managed, digital credit also runs the risk of excluding, over-charging, and over-extending customers.

Seven years since the first digital credit product launched, the market in Kenya has grown exponentially and hosts a diverse ecosystem with more than 50 supply-side actors. The phenomenal expansion of digital credit in Kenya serves as a test-bed for the product and offers lessons for digital credit suppliers and regulators around the world.

SPTF and the Smart Campaign commissioned MicroSave Consulting (MSC) to study the dynamics of the digital credit sector on both demand and supply sides. The output of the study was a <a href="https://content.centerforfinancialinclusion.org/making-credit-truly-responsible-webinar/">comprehensive report on the current state of digital credit in Kenya</a>. It looked at the evolving challenges in digital credit and made recommendations for a more responsible and customer-centric delivery of the product.

With participation from Smart Campaign Senior Director Alexandra Rizzi, this webinar:
<ul>
 	<li>Helps participants understand the digital credit landscape in Kenya</li>
 	<li>Assesses the progress and challenges around making digital credit responsible and inclusive</li>
 	<li>Recommends steps towards a more responsible delivery of digital credit</li>
</ul>

Making Digital Credit Truly Responsible Webinar

All is not well in the country that pioneered mobile credit. A new <a href="/making-digital-credit-truly-responsible">report on digital credit in Kenya</a> from <a href="https://www.microsave.net/">MSC</a>, commissioned by <a href="/about/what-we-do/the-smart-campaign">the Smart Campaign</a> and the <a href="https://sptf.info/">SPTF</a>, shows that with continued dramatic growth rates, the sector also experiences cripplingly high default and delinquency, enabled by poor business practices and weaknesses in both the credit reporting infrastructure and regulatory jurisdiction.

Most notably, the report reveals very high rates of delinquency and default. Among active digital loans, more than a quarter are non-performing. About 2.2 million Kenyans are said to have delinquent loans. In some cases, liberal use of refinancing and rescheduling hides this level of delinquency in lender portfolios. At the same time, the report points out that about half of these non-performing loans are for amounts less than $10. These findings are broadly consistent with results cited by CGAP in 2016, which found that 50 percent of digital borrowers in Kenya repaid their loans late, and 12 percent defaulted.
<blockquote>Despite continued growth of digital credit in Kenya, high delinquency, default and interest rates persist in the market and credit bureaus haven't yet caught up with the digital age.</blockquote>
The report also details shortcomings in credit reporting, given that many digital lenders neither consult nor report to the credit reporting bureau as fully or regularly as they should. The credit reporting bureaus were clearly set up for a pre-mobile era, which suffer from issues related to inclusion of all types of lenders, frequency of uploading data (monthly, when daily is more relevant for today’s short term loans), and ease of connection among all the players in the credit reporting ecosystem. As a result, many lenders are not consistently using credit bureaus—neither ensuring that the information is updated and correct, nor fully consulting it prior to lending.

Pricing is also an issue. The market leader, M-Shwari, which accounts for about two-thirds of all digital loans, charges an annual percentage rate (APR) of 90 percent. The low-price option provided by Kenya Commercial Bank is a fairly reasonable 44 percent APR, but the high end of the price range includes providers charging APRs well into the hundreds. Granted that these are small, short term loans where interest payments are not expected to be sustained for an entire year. Nevertheless, the promise of digital to bring down prices does is not yet in sight.

Other issues noted in the report include non-transparency regarding portfolio quality, identity theft, misuse of client data, multiple borrowing and loan bicycling by clients, and client use of loan proceeds for sports betting.

The picture that emerges suggests that the still-exploding market of very small, “nano” loans needs to be brought into more orderly operation. Consumers and providers are operating in risky ways. The current state of the market is not beneficial for either.
<blockquote>Raising the bar for blacklisting customers and public awareness about defaulting on loans are among our recommendations for improving digital credit.</blockquote>
One issue specific to this nano-loan market concerns the reporting of very small non-performing loans to credit bureaus, with negative consequences, such as curtailing of access to credit, for hundreds of thousands of borrowers. MSC, the Smart Campaign and SPTF recommend that regulations be put in place such that delinquencies and defaults among loans below some fixed amount not be reported to the credit bureau (whether US$2, $5 or $10 – the report actually recommends a cutoff of 5% of the monthly per capita GDP). It also recommends that the government launch a public awareness campaign about how credit bureaus work and the consequences of default so consumers will better understand the risks involved in borrowing.

The regulators, credit reporting agencies and lenders in Kenya are aware of these concerns and working to improve the situation. A new association of digital lenders (Digital Lenders Association of Kenya) has been formed to create consumer protection standards and the central bank is exploring ways to upgrade the credit reporting ecosystem. The Smart Campaign recommends that both lenders and regulators consider adopting the <a href="http://www.smartcampaign.org/about/smart-microfinance-and-the-client-protection-principles/digital-credit-standards">digital credit standards</a> and <a href="https://www.smartcampaign.org/tools-a-resources/1210-handbook-on-consumer-protection-for-financial-inclusion">model regulations</a> covering issues ranging from transparency, to the fair use of algorithms, to protection of customer data.

Kenya’s unprecedented dynamism in mobile money, digital credit and financial inclusion is envied across the world. If authorities and providers can bring the participants in these sectors into a better-functioning marketplace, Kenya will benefit greatly from the innovation the country continues to spawn.

Red Flags in Kenya’s Nano-Credit Market

<span class="hotkey-layer ">Digital credit has emerged as a new and profitable service offering that has a great potential to increase financial inclusion. Yet, if it is not carefully managed, digital credit runs a great risk to exclude, over-charge, and create over-indebtedness.</span>

<span class="hotkey-layer ">During the first half of 2019, The Smart Campaign and the Social Performance Task Force (SPTF) commissioned Microsave Consulting (MSC) to study the current state of digital credit in Kenya and formulated recommendations for how to make digital credit delivery safer and more customer-centric. We propose that </span>regulations be put in place such that delinquencies and defaults among loans below some fixed amount not be reported to the credit bureau so as not to unduly burden consumers. We also call for increased public awareness campaigns about how credit bureaus work and the consequences of default so consumers will better understand the risks involved in borrowing.

More generally, the Smart Campaign recommends that both lenders and regulators consider adopting the <a href="http://www.smartcampaign.org/about/smart-microfinance-and-the-client-protection-principles/digital-credit-standards">digital credit standards</a> and <a href="https://www.smartcampaign.org/tools-a-resources/1210-handbook-on-consumer-protection-for-financial-inclusion">model regulations</a> covering issues ranging from transparency, to the fair use of algorithms, to protection of customer data.

Making Digital Credit Truly Responsible

Digital credit has emerged as a new and profitable service offering that has great potential to increase financial inclusion. Yet, if not carefully managed, digital credit also runs the risk of excluding, over-charging, and over-extending customers.

Seven years since the first digital credit product launched, the market in Kenya has grown exponentially and hosts a diverse ecosystem with more than 50 supply-side actors. The phenomenal expansion of digital credit in Kenya serves as a test-bed for the product and offers lessons for digital credit suppliers and regulators around the world.

SPTF and the <a href="/about/what-we-do/the-smart-campaign">Smart Campaign</a> commissioned MicroSave Consulting (MSC) to study the dynamics of the digital credit sector on both demand and supply sides. The output of the study was a comprehensive report on the current state of digital credit in Kenya. It looked at the evolving challenges in digital credit and made recommendations for a more responsible and customer-centric delivery of the product.

With participation from Smart Campaign Senior Director <a href="/bio/alexandra-rizzi">Alexandra Rizzi</a>, this webinar will:
<ul>
 	<li>Help participants understand the digital credit landscape in Kenya</li>
 	<li>Assess the progress and challenges around making digital credit responsible and inclusive</li>
 	<li>Recommend steps towards a more responsible delivery of digital credit</li>
</ul>
We hope you can join us!

<img class="alignnone size-large wp-image-36766" src="https://content.centerforfinancialinclusion.org/wp-content/uploads/sites/2/2019/09/MSC_Webinar-1-1024x683.jpg" alt="Infographic describing webinar schedule" width="1024" height="683" />

Webinar: Making Digital Credit Truly Responsible

Alexandra (Alex) Rizzi

Senior Research Director, Consumer Data Opportunities and Risks

Mayada El-Zoghbi

Managing Director

Maria Gabriela Coloma Ponce de Leon

Joana Afonso

Daniel Rozas

Pallavi Hariharan

Matteo  Marinelli

Chiara Pescatori

Narasimhan Srinivasan

Alex Kessler

Hema Bansal

Elisabeth Rhyne

Rachel Morpeth

Chris Wolff

Isabelle Barrès

Tanwi Kumari

John Owens

Kenya

Sub-Saharan Africa

Bosnia and Herzegovina

Europe and Central Asia

East Asia and Pacific

Myanmar

India

South Asia

Cambodia

North America

United States

Tanzania

Alternative Data

Client Treatment

Consumer Protection

Credit

Credit Provision

Digital Credit

Financial Service Providers

Financial Technology

Fintechs

Interest Rates

Over-indebtedness

Responsible Digital Finance

Underwriting

Challenges and Crises

Enabling Environment

Microfinance

Microfinance Institutions

Smart Certification

Policy, Regulation and Government Initiatives

Complaint Resolution

Financial Inclusion Strategy

Customer Centricity

Default

Delivery Channels

Digital Financial Services

Nano Loans

Product Pricing

Transparency

Partnerships

Telcos

Informal Credit

Fraud

Mobile Banking

Privacy

Blog Post

Brief

Webinar

Report

Event

The majority of Kenyans have mobile money accounts; their activity demonstrates digital financial services’ potential. Accion helps Kenyan innovators harness emerging technologies to create new financial services.

India is a global leader in financial inclusion. For over a decade, Accion has worked with and learned from India’s innovators, investors, and policymakers to expand economic opportunity for its people and businesses.

The term “rural brain drain” was popularized nearly a decade ago when two sociologists published a book documenting <a href="https://www.wired.com/2010/02/how-do-we-stop-hollowing-out-the-middle-of-america/">their experience living in Iowa</a>. Their goal was to understand the exodus of a young, educated workforce from rural areas to urban hubs. Today there are many factors contributing to this population shift, among them deindustrialization, lack of high-paying jobs, and weak broadband connectivity. A <a href="https://www.federalreserve.gov/publications/files/consumer-community-context-201901.pdf?mod=article_inline">Federal Reserve</a> report published earlier this year brought to light another reason for this phenomenon that dozens of states are grappling with: student loan debt.

The student debt crisis made headlines in 2010 when student loan debt surpassed credit card debt in the United States, at a staggering $1.56 trillion today, student debt is growing much faster than <a href="https://www.finder.com/student-loans-to-overtake-mortgages">mortgage debt</a> (10.4 percent per year versus 0.6 percent for mortgages). According to the Federal Reserve Bank of New York, nearly two-thirds of this financial burden falls on Americans under the age of 39.

As young people are increasingly burdened by student debt, they are flocking to the places that offer high-paying jobs: cities. According to Pew Research, <a href="https://www.pewresearch.org/fact-tank/2018/03/16/how-millennials-compare-with-their-grandparents/">88 percent</a> of millennials live in metropolitan areas. The average age is higher in <a href="https://www.citylab.com/life/2018/05/mapping-americas-aging-population/561200/">the Midwest and the Appalachians</a>, regions that are struggling to keep pace with urban hubs in terms of broadband access, variety of jobs, quality of higher education institutions, and other success factors in today’s markets. As evidenced by the Fed’s report, individuals with student debt are less likely to remain in rural areas than those without debt. Furthermore, nearly two-thirds of the students most burdened by debt leave rural areas within one year after entering repayment. The term for this migration pattern has been coined the “rural brain drain,” and its impacts on the economic vitality of these regions are increasingly apparent. The inability of rural areas to attract a young, educated workforce is deepening the rural-urban divide.
<blockquote>Young people are flocking to the places that offer high-paying jobs: cities.</blockquote>
Some may argue that widespread access to education loans has created better opportunities for younger populations all over. However, according to U.S. Census data, wages have been stagnant since the 1970s, while the average cost of public college tuition has increased almost four fold. Simultaneously, homeownership among those under 35 has dropped <a href="https://www.census.gov/library/stories/2018/08/homeownership-by-age.html">10 percent</a> since 2006, and birth rates have declined every year since 2007. People in the age groups we might expect to be buying homes, settling down, and raising the next generation cannot afford to do so.
<blockquote>Wages have been stagnant since the 1970s, while the average cost of public college tuition has increased almost four fold.</blockquote>
We often look to countries like Finland, Denmark, and Norway, which offer tuition-free college to their citizens, as paradigms of what could exist here at home. Which country has the best model for us to try to replicate? According to former Secretary of Labor Robert Reich, the answer is <a href="http://inequalityforall.com/wp-content/uploads/2014/12/A_Visual_StoryPDF.pdf">the United States</a>. In post-war America, tuition fees were waved for veterans, and there was a massive proliferation of public universities. The GI Bill was one of the important factors that led to a tripling of the number of Americans with a bachelor’s degree from 1950 to 1977, and these educated workers helped the U.S. to grow to have the largest and most prosperous middle class in the world. At this time, public tuition was about 6 percent of an average male salary, compared to today’s 25 percent.

Times have changed, however, and modern problems require modern solutions. Refinancing and forbearance can provide some relief, but they ultimately increase debt in the form of interest. Other <a href="https://www.forbes.com/sites/andrewjosuweit/2017/11/05/6-ways-congress-can-help-ease-the-student-loan-crisis/#1cdcbb656cf6">proposals</a> to remedy the student debt crisis include erasing all debts, boosting the tax deduction for those making on-time payments, expanding the Pell grant program, creating a tiered system that lowers or eliminates debt based on income, and proper adherence to the <a href="https://www.nerdwallet.com/blog/loans/student-loans/public-service-loan-forgiveness/">Public Service Loan Forgiveness Program</a>. The latter program was created in 2007 to forgive remaining student loan balances of those who have worked for 10 years in public service. In 2017 applicants first became eligible for relief through this program, which has a two-year budget of $700 million. However, as of April this year, only 1.5 percent of those funds have been utilized. While the <a href="https://studentaid.ed.gov/sa/repay-loans/forgiveness-cancellation/public-service/temporary-expanded-public-service-loan-forgiveness#how-qualify">requirements</a> for forgiveness are publicly available, the Department of Education has come under fire for not providing clear guidance to successfully navigate them.

Some believe that a policy to eliminate all or most student debt would be a major <a href="https://www.marketwatch.com/story/canceling-14-trillion-in-student-debt-could-have-major-benefits-for-the-economy-2018-02-07">economic stimulus</a>, spurring job creation and narrowing the wealth gap over the next decade. Our recent history proves that a well-educated population fuels a virtuous cycle of growth through competitive wages, increased tax revenues, and expansion of jobs. An affordable education lies at the foundation of this cycle, and will be a key factor in creating a more economically inclusive rural and urban America.

Rural America: Another Casualty of Student Loan Debt?

Discussions about digital credit default rates have critiqued the "how" it gets delivered, but an alternative view is to blame "what" is being offered and conclude that more diverse and useful DFS are needed sooner. The digital credit so far in the form of the uniform, very small amount nanoloans aren’t delivering a strong enough value proposition in meeting specific needs to rank them high in a person’s order of expenses to cover and debts to repay.

How do we know that improving value propositions of DFS hold promise as a solution to defaults? Looking to two markets whose mobile money ecosystems have had more time to develop credit products can provide clues.

In this post, I'll compare digital credit in Kenya and Tanzania. CGAP’s research reveals <a href="https://www.cgap.org/sites/default/files/publications/Working-Paper-A-Digital-Credit-Revolution-Oct-2018.pdf">Tanzania’s default rate is 31 percent, almost 3 times higher than Kenya’s</a>. Why do these neighbors have such drastically different default rates? Apart from other <a href="https://fsdkenya.org/blog/four-differences-and-five-similarities-of-digital-credit-markets-in-kenya-and-tanzania/">distinctions</a>, two differences embedded in the research are:
<ul>
 	<li>Kenya has diversified the range and number of products on the market.</li>
 	<li>Tanzanians consistently preferred to use informal sources rather than digital credit.</li>
</ul>
Compare the data from the graphs below, from "<a href="https://www.cgap.org/sites/default/files/publications/Working-Paper-A-Digital-Credit-Revolution-Oct-2018.pdf">A Digital Credit Revolution: Insights from Borrowers in Kenya and Tanzania</a>," a CGAP/FSD working paper published October 2018.

Diversifying Digital Financial Services: A Way to Tackle Defaults and Over-Indebtedness

Join <a href="/about/what-we-do/the-smart-campaign/">Smart Campaign</a> Director <a href="/bio/isabelle-barres">Isabelle Barrès</a> at <a href="https://registration.european-microfinance-week.eu/ehome/emw2018/758265/">European Microfinance Week</a> in Luxembourg November 14-16, 2018. Organized by the European Microfinance Platform (e-MPF), the conference will welcome more than 500 professionals to discuss multiple aspects of financial inclusion.

<strong>Thursday, November 15th, 11am-12:30pm</strong>
Isabelle will be presenting findings from the Smart Campaign’s research with members of the Fintech Protects Community of Practice in a session entitled, “Client Protection and Digital Finance, Practices from Kenya.”

<strong>Friday, November 16th, 11am-12:30pm</strong>
Isabelle will participate in a panel discussion, “Preventing Overindebtedness in Cambodia: Can Self-Regulation Work?”

&nbsp;

&nbsp;

&nbsp;

European Microfinance Week 2018

India is one of the fastest growing and complex markets for inclusive finance, where there is a huge opportunity to extend financial services to the underserved. Yet the country has struggled in the past with unbridled growth of the microfinance sector leading to a crisis in debt stress, notably in <a href="https://www.huffingtonpost.com/elisabeth-rhyne/on-microfinance-whos-to-b_b_777911.html">Andhra Pradesh</a> in 2010.

Policymakers and networks of microfinance institutions actively responded to these crises and elevated consumer protection on the policy agenda. But it’s one thing for regulators to signal policy support for consumer protection. It’s quite another to tackle the nuts and bolts of implementing best practices, especially in such a complex market as India.

[caption id="attachment_33139" align="alignleft" width="500"]<img class="wp-image-33139" src="https://content.centerforfinancialinclusion.org/wp-content/uploads/sites/2/2018/10/Sa-Dhan-tool-launch-photo-1024x714.jpg" alt="announcement-of-sadhan-monitoring-tool-group-photo" width="500" height="349" /> The Sa-Dhan monitoring tool was announced at a launch event during the Sa-Dhan Annual Conference in New Delhi in September 2018.[/caption]

One of the scalable solutions to arise in India is the concept of microfinance networks as Self-Regulatory Organizations (SROs). Networks that have been designated by the Reserve Bank of India (RBI) as SRO networks are responsible for monitoring compliance of member MFIs to the microfinance industry code of conduct and providing an effective grievance redressal mechanism between borrowers and member institutions. <a href="http://www.sa-dhan.net/">Sa-Dhan</a>, the largest organization of community banks in India, was designated an SRO in 2015. While Sa-Dhan had previously filled a quasi-regulatory role, this official designation expanded its mandate for monitoring and enforcement, in turn expanding its need for tools to identify and respond to risks at both the market and institution levels.

Aiming to make a country-wide impact on the state of consumer protection in India, CFI’s <a href="https://www.smartcampaign.org/">Smart Campaign</a> and Accion’s Global Advisory Services collaborated with Sa-Dhan to build a digital monitoring tool based on the Smart Campaign’s <a href="https://www.smartcampaign.org/about/smart-microfinance-and-the-client-protection-principles">global standards for financial consumer protection</a> and local regulatory guidelines. The tool is to be the vehicle through which Sa-Dhan collects the information it needs from its members to fulfill its supervisory role in monitoring compliance with the code of conduct. Accion’s advisory team led the digitization of the tool, building of the data warehouse, and the corresponding web platform. The tool was officially launched at Sa-Dhan’s annual conference with technical and financial support from the International Finance Corporation. Sa-Dhan’s members can now efficiently self-report data through the tool’s online interface and Sa-Dhan can quantitatively assess market dynamics, especially areas of over-indebtedness risk.
<blockquote>The tool is to be the vehicle through which Sa-Dhan collects the information it needs from its members to fulfill its supervisory role in monitoring compliance with the code of conduct.</blockquote>
This new monitoring mechanism will help to instill consumer protection in Sa-Dhan’s nearly 200 member MFIs and protect more than 30 million clients in India.

Across the microfinance sector new examples of “regtech” and “suptech” are emerging. Just as technological transformation of MFIs can scale their services to new clients, technology can help regulatory bodies meet their broadened responsibilities to oversee the proliferation of lenders. P. Satish, Executive Director of Sa-Dhan sees the new tool as an essential component to meeting its SRO mandate through technology that will “help member MFIs with their data analytics and compliance measures, as well as reduce potential client distress.”

After the initial rollout and training workshops for MFIs across the country, Sa-Dhan will put the tool into practice and will use the reports in consultation with the RBI to identify “hot spots” of overindebtedness or lack of compliance to the code of conduct. These reports will also help Sa-Dhan identify under-penetrated areas and help lenders to expand services.

India’s experimentation with self-regulation holds lessons for the world. Traditionally, self-regulation models have been met with skepticism, especially regarding how non-government networks can monitor and enforce compliance among members. The collaboration between the RBI and SROs in India give weight to the microfinance networks through a layered regulatory approach, and technology advances can build capacity of networks like Sa-Dhan to access data from their members and oversee performance.

The Sa-Dhan monitoring tool can serve as a model for expanding consumer protection in other markets, especially those where there are concerns of rising debt stress. Better monitoring tools can serve as an early warning system and help provider networks or regulators head off crises before they spread.

A New Digital Monitoring Tool in India Could Boost Consumer Protection Capacity

This conference provides a unique platform for dialogue, deliberation, information sharing and forging partnerships. It aims to provide stakeholders with a platform to deliberate on specific sectoral concerns and challenges in the implementation of India’s Financial Inclusion program. The theme of this year's National Conference is "Propelling the Growth of the Informal Sector Through Microfinance."

The Smart Campaign is attending the Sa-Dhan Annual Conference in New Delhi, India to unveil a new client protection tool developed in partnership with the Sa-Dhan association of community development financial institutions. This new tool will allow the association to monitor its members to ensure compliance with its Code of Conduct, as well as collect information about over-indebtedness risks for clients at member institutions. Tanwi Kumari and Hema Bansal of The Smart Campaign will be speaking at the event.

Sa-Dhan National Conference

As digital credit providers have grown exponentially over the past few years, and as digital products and models have proliferated, so too have concerns around consumer protection. In the recently published report, <a href="http://www.centerforfinancialinclusion.org/publications-a-resources/browse-publications/1036-responsible-digital-credit">Responsible Digital Credit</a>, I argue that ensuring that digital credit customers receive responsible treatment requires more than enhanced consumer protection laws and regulations. It also requires strong commitment from the digital credit industry. Finally, it needs consumers who are empowered to play a more proactive role in managing their digital credit responsibly.

Over the past year, I have interviewed digital credit industry associations, credit providers and their third-party data analytic providers, regulators, policy makers, and various consumer protection leaders. Many of these groups are working to develop responsible digital lending principles. With their input, my report proposes a guiding framework for responsible digital lending.  The framework uses the Smart Campaign <a href="https://www.smartcampaign.org/about/smart-microfinance-and-the-client-protection-principles">Client Protection Principles</a> as a basis for grouping the issues. In addition, I propose an eighth principle: security and fraud protection.

Digital credit, and especially the use of mobile phones, significantly alters interactions between borrowers and lenders. Lenders utilizing the mobile channel to advertise, acquire and transact with customers must pay particular attention to the limitations of mobile interaction with customers and follow industry <a href="http://onlinelendersalliance.org/wp-content/uploads/2016/03/Best-Practices-2016-1.pdf">mobile best practices</a>. While many of the standard consumer protection practices continue to apply, new concerns, or more accurately, new faces on older concerns, have emerged. In this post, I want to highlight several of the considerations I found most important and relevant for the digital lending industry.
<h2><strong>Responsible Algorithms</strong></h2>
Many digital credit models rely on algorithms to process data about clients and make credit decisions. Because most lenders consider their algorithms proprietary, it is difficult for observers to know on what basis credit decisions are actually made. This opaque situation raises the spectre of discrimination. Attributes that are considered inappropriate bases for differentiation, such as religion, language, gender, or ethnic origin, are areas of particular concern with regard to algorithm-based lending practices. As highlighted by a Smart Campaign <a href="http://www.centerforfinancialinclusion.org/publications-a-resources/browse-publications/916-smart-brief-tiny-loans-big-questions">report</a>, while credit offers may differ based on risk analysis, such differentiation should be consistently applied, stated in advance, and made with the goal of benefitting clients. To prevent discriminatory digital credit practices, some recommendations include:
<ul>
 	<li><a href="https://www.whitecase.com/publications/insight/algorithms-and-bias-what-lenders-need-know"><strong>Pretest, test and retest for potential bias</strong></a><strong>.</strong> Digital credit providers and third-party data analytics providers should continuously monitor the outcomes of their algorithmic programs to identify potential problems. Such testing could involve running scenarios to identify unwanted outcomes and developing and building controls that prevent adverse outcomes.</li>
 	<li><a href="http://www.ijmo.org/papers/43-A10212.pdf"><strong>Document the rationale for algorithmic features</strong></a><strong>.</strong> Digital credit providers should be able to provide visualization and a decision tree for the factors their algorithms analyze, as well as the justification for relying on these factors. The rationale should address how borrower debt capacity is assessed, given the importance of this concept in traditional underwriting.</li>
 	<li><strong>Independent review</strong> of companies' proposed data sets and/or algorithms.</li>
</ul>
A self-regulatory approach could be used to develop best practices guidelines for data inputs and the development of nondiscriminatory artificial intelligence systems, following the model that has been successful for the Payment Card Industry Security Standards Council.
<h2><strong>Indebtedness Monitoring</strong></h2>
Because digital lending is often based on non-traditional underwriting criteria, to prevent over-indebtedness among digital borrowers it may be relatively more important to monitor outcomes at the portfolio level. Some of the ways to do this include:
<ul>
 	<li><strong>Avoidance of debt traps</strong> by ensuring that clients are not forced into automated repeat loans.</li>
 	<li><strong><a href="http://www.responsiblebusinesslending.org/">Responsible credit reporting</a></strong> – Better compliance with reporting strengthens markets and leads to better client protection practices.</li>
 	<li><strong><a href="http://www.centerforfinancialinclusion.org/storage/documents/Smart_Brief_Tiny_Loans_Big_Questions_Final_092617.pdf">Monitoring digital credit provider’s portfolio quality</a></strong> – Industry benchmarks for portfolio quality can help to advance the understanding of risks and avoid business models that rely for their success on high default rates.</li>
</ul>
<h2><strong>Digital Transparency </strong></h2>
Digital credit platforms allow for 24/7 communications with clients that, if harnessed properly, can assist them with immediate technical support, remind them about upcoming payments and even identify counselors or resources for clients in financial stress. However, when communication is totally digital, there are heightened concerns about ensuring that clients really know what they are signing up for. Disclosure must lead to client understanding. Borrower disclosure standards should address:
<ul>
 	<li>Standards for <strong>honest advertising</strong> and penalties for misleading marketing materials of credit products. Furthermore, providers should advertise the name of the financial regulator they report to in all advertising materials.</li>
 	<li><strong>Readability</strong> and format – Disclosures need to be easy to comprehend, available in the customer’s local language, and provided in print and digital formats.</li>
 	<li><strong>Comparative tools</strong> – Standard summary disclosure documents would allow borrowers to compare credit offers, both digital and traditional.</li>
 	<li><strong>Adequate notice periods</strong> – Consumers should be notified in advance of changes to interest rates, fees or terms and conditions.</li>
</ul>
A somewhat different but related and relevant concern, often overlooked in this context, is the vulnerability of individual investors who put their money into pure peer-to-peer (P2P) lending platforms. Protections need to be extended to them as well, with a focus on ensuring that they receive the information they need to evaluate risks and that they have recourse channels when something goes amiss.
<h2><strong>Data Privacy and Usage Standards</strong></h2>
While many regulators and most industry groups agree that it is important to protect the confidentiality and security of customers’ information, data use and the level of disclosure about its use are challenging topics. In the <a href="http://ec.europa.eu/justice/data-protection/reform/index_en.htm">EU</a> and in countries such as <a href="https://www.pc.gov.au/inquiries/completed/data-access/thedraft">Australia</a>, regulators are enacting rules mandating that individuals be notified about the use of their personal data and allowed to opt out. Opt-out rules should be considered as a potential requirement for all digital credit providers, especially in markets where mobile push-marketing has become problematic.

Over the next several years it will be important for laws or regulations to be put in place to protect consumer data privacy and guide information sharing. The rules need to:
<ul>
 	<li>Provide for informed consent, such that customers explicitly permit electronic data collection prior to its collection and use, and are given the option to consent or not.</li>
 	<li>Require providers to have a clear data collection and handling policy which limits the amount of data collected as well as the timeframe it is stored.</li>
 	<li>Inform clients about their data trails and credit histories, including the ability to ensure accuracy and correct for any errors or discrepancies.</li>
 	<li>Give regulators the power to discipline providers who repeatedly allow personal data to be misused.</li>
</ul>
<h2><strong>Fraud Prevention and Security </strong></h2>
New security vulnerabilities arising from digital credit strongly point to fraud and cyber-security as consumer protection concerns. It is increasingly urgent for digital credit providers to adopt standard security compliance measures and then to regularly test and update them. Providers must also be responsible for ensuring that the third-parties they use, including lead generators, brokers, agents, and data analytics providers, also have adequate security in place. Ultimately, providers need to be responsible for the actions of their third-parties (e.g., agents, contractors, lead generators, brokers and collectors).

Consumers should be made aware of the potential for fraud and encouraged to report suspected fraud cases or security breaches. Consumer awareness campaigns on the most common incidents of fraud (via the internet, SMS alerts, signage at agent kiosks, etc.) can help with this.

While the recommendations just listed do not apply in all markets, they do point to the urgent need for regulators, industry bodies, individual providers and consumers to work together to construct the ground rules for responsible digital credit that will ensure that consumers are adequately protected.

<em>Editor's Note: This research was made possible by support from Mastercard Foundation and other partners.</em>

&nbsp;

A Framework for Responsible Digital Credit

<span style="float: none;background-color: transparent;color: #333333;cursor: text;font-family: Georgia,'Times New Roman','Bitstream Charter',Times,serif;font-size: 16px;font-style: normal;font-variant: normal;font-weight: 400;letter-spacing: normal;text-align: left;text-decoration: none;text-indent: 0px">Despite the rise in mobile money in Africa, and globally, the gap between supply and demand for credit in the region remains. Surprisingly, in this milieu, start-ups are at risk of accelerating the pace of over-indebtedness in Africa. The number of start-ups reaching last mile clients is rising. The driver of this is fintechs taking advantage of a business opportunity, and the prospect that if you offer clients much-needed credit at a lower cost than the alternative, they will be better off.</span>

But is this necessarily true? Are these start-ups offering solutions to the credit needs that many small and medium African businesses have, and are clients better off with these solutions? Or is the fintech digital credit hype attracting lenders that offer credit in the wrong places – and for the wrong reasons? What is needed to ensure that digital credit is provided responsibly, for the benefit of clients?
<h4><strong>Start-ups are at risk of accelerating over-indebtedness by supplying credit to clients without conducting appropriate repayment capacity analysis.</strong></h4>
Some estimate that digital technologies have cut the cost of providing financial services by 80-90 percent (<a href="http://appgfintech.org.uk/wp-content/uploads/2016/11/MG-Digital-Finance-For-All-Full-report-September-2016.pdf">McKinsey Global Institute, 2016, PDF</a>). Africa is taking the lead in the rise of mobile technology, and the opportunities are promising. Start-ups in this space are making big strides. Those involved in digital credit either deliver digital credit directly or enable its delivery through downstream product servicing. The number of fintechs – startups offering these services – in Africa is growing daily (<a href="http://fintechranking.com/2016/12/15/63-companies-shaping-africas-fintech-ecosystem/">Mesropyan, 2016</a>).

Technology well used offers opportunities not previously available. However, two key issues need to be recognized and addressed in order to generate long-term benefits for both clients and providers.
<ol>
 	<li>Provider and client interests must be aligned. If providers profit while clients are experiencing stress in repaying, defaults will catch up with the client or the institution, and the client will no longer be able to borrow. Aligning interests requires providers to think of client benefits as well as their own, from the start.</li>
 	<li>A well-designed loan should match the ability to repay. Well-designed loans are a blessing, for example, helping a small business; yet loans that do not consider clients’ capacity to repay sets them up for failure. Even if they repay in the short term – which is often why default rates stay low – it can be at the cost of extreme hardship, making it a poor predictor of over-indebtedness. It may take some time before the debt stress of clients affects providers.</li>
</ol>
<h3><strong>"Instant": an Opportunity and a Risk for Consumers</strong></h3>
A key attribute digital lenders advertise is speed of access. Where traditional loans could take weeks for approval, with many requirements, this is a plus from the perspective of clients. But the automation and speed raises concerns: are decisions made too quickly, and are risks adequately measured and mitigated, especially from the clients' perspective?

Other aspects of digital credit lead to <a href="http://www.centerforfinancialinclusion.org/publications-a-resources/browse-publications/916-smart-brief-tiny-loans-big-questions">new risks</a> compared with analog lending: start-to-finish digitization; the move from high to low touch processes; small credit amounts that grow; short-term loans; reliance on alternative data analytics; and decentralized support workforces.
<h3><strong>What Could Go Wrong?</strong></h3>
With analog credit, prevention of over-indebtedness centered on adequate repayment capacity, and on growth not taking place at the expense of quality.

In the digital context, the following major categories of risk have been identified (Center for Financial Inclusion, 2017/2018. See References):
<ul>
 	<li>Limited – if any – debt capacity analysis</li>
 	<li>Products that do not match client needs</li>
 	<li>Lack of credit reporting</li>
 	<li>Automatic renewals</li>
 	<li>Aggressive sales and marketing</li>
 	<li>Disproportionate consequences of late payments that lead to a cycle of debt.</li>
</ul>
<h4><strong>Algorithms are institution centric, not client centric. Over-indebtedness is not only reflected in default, it is first reflected by the extent of the sacrifices that the client endures to avoid defaulting.</strong></h4>
Alternative credit scoring methods – often using elaborate algorithms that predict the probability of repayment – help to include people who have thin credit files and who would otherwise have been excluded. However, these models are a poor replacement for the repayment capacity analysis previously conducted by lenders serving vulnerable excluded populations. While the algorithm may predict whether or not an institution will be repaid, it does not consider clients' situations and needs, and therefore, the sacrifices that clients might have to make in order to repay. Over-indebtedness is not only reflected in default, it is first reflected by the extent of the sacrifices that the client endures to avoid defaulting. Algorithms are institution centric, not client centric. They are meant to learn over time, becoming refined and better predictors; yet they do so at the expense of early clients who enabled the algorithm to become better fine-tuned, as they have a higher probability of defaulting and suffer dire consequences (<a href="https://www.businessdailyafrica.com/economy/Pain-of-Kenyans-blacklisted-for-amounts-as-small-as-Sh100/3946234-3374120-r0r2bfz/index.html">Ngigi, 2016</a>).

The promise of well-tuned algorithms saving costs and managing institutional risk is unfortunately skewing attention away from client risks. Over-indebtedness needs to be reframed from a client perspective: can clients afford the loan? Even if they can repay, what sacrifices are they making? Are they at risk of not being a client ever again in the future (which would hurt both the client and the provider)?
<h3><strong>Mitigating Over-Indebtedness in a Digital World</strong></h3>
Over-indebtedness is a multi-stakeholder issue, and is linked to the client protection issues summarized in the <a href="https://www.smartcampaign.org/about/smart-microfinance-and-the-client-protection-principles">Client Protection Principles</a>. Prevention of over-indebtedness is a particularly tricky one, in that it requires the concerted effort of a wide range of stakeholders.

Providers have a responsibility to ensure that their practices do not lead to an oversupply of credit to clients who are unable to meet their payment obligations, and digital lenders will need to adopt a more client-centric approach to understand the risks of over-indebtedness from a client perspective. Algorithms need to evolve to take this into account.

Digital lenders need to understand the risks of over-indebtedness from a client perspective, and algorithms need to evolve to take this into account. Regulation also must guide good practice for fintech digital lenders<strong>.</strong>

Because only one irresponsible lender is needed in terms of over-indebtedness to negatively affect clients, it is necessary that financial consumer protection regulation evolves to guide the practices of otherwise unscrupulous digital lenders.

Investors can, and should, use their leverage to encourage good practices by digital lenders, as they have for analog lenders. They can reward digital lenders who design and deliver appropriate products, are transparent about terms and conditions, explain to clients the risks of over-indebtedness, adopt fair and responsible practices during repayments, and help clients who cannot, but want to, repay.

Importantly, digital providers can leverage the same technology used to deliver products to educate and empower clients. Clients have rights and responsibilities. Informed consumers are better able to protect themselves and avoid becoming victims of predatory lenders.
<h3><strong>Over-Indebtedness Is Multidimensional and Dynamic</strong></h3>
In the interest of long-term mutual benefits for both providers and clients, providers need to move away from a uni-dimensional definition of over-indebtedness that overly emphasizes repayment as the proxy for whether or not a client is indebted, towards <a href="http://www.centerforfinancialinclusion.org/publications-a-resources/browse-publications/201-over-indebtedness-of-microborrowers-in-ghana-an-empirical-study-from-a-customer-protection-perspective">client-focused definitions of over-indebtedness</a>.

Digital credit providers need to complement credit bureau data with disbursement and repayment data on digital loans so that a fuller financial picture can emerge for digital borrowers.

Over-indebtedness is not a steady state. As the lives of vulnerable clients evolve, so do their needs and challenges. A client who may have received a loan from a responsible lender in the past may suddenly not be in a position to repay. We need to develop ways to monitor whether clients are showing signs of financial stress. Responsible institutions should be able to identify this, and work with clients until it is resolved.

The role of responsible providers goes beyond providing loans to ensuring that clients are supported, if needed. <a href="https://www.microfinanceopportunities.org/">Microfinance Opportunities</a>, in collaboration with <a href="http://socialperformance.net/">Social Performance Solutions</a>, has been developing a stress assessment tool that enables providers to monitor whether borrowers are incurring stress after having received a loan. Such tools are extremely important to have a full picture of over-indebtedness, and a broader suite of tools needs to be available to responsible providers.
<h3><strong>Fintech Protects Against Over-Indebtedness</strong></h3>
Fintech digital credit providers need to unite and agree to collective measures to tackle the problem of over-indebtedness. This will entail defining responsible digital underwriting, leveraging technology, while learning from the past, expanding credit bureau reporting, and agreeing on common practices for the benefit of clients. Some fintechs are already taking the lead, and through the Smart Campaign’s <a href="http://www.smartcampaign.org/about/fintech-protects-community-of-practice">Fintech Protects Community of Practice</a>, they are working together to define and implement responsible practice. The body of evidence around risks is growing. Now is the time to define the guidelines of good practice for fintech digital lenders and identify solutions that work for clients.

<strong>References</strong>

McKinsey Global Institute, “<a href="http://appgfintech.org.uk/wp-content/uploads/2016/11/MG-Digital-Finance-For-All-Full-report-September-2016.pdf">Digital Finance for All: Powering Inclusive Growth in Emerging Economies</a>,” September 2016.

Elena Mesropyan, “<a href="http://fintechranking.com/2016/12/15/63-companies-shaping-africas-fintech-ecosystem/">63 Companies Shaping Africa’s FinTech Ecosystem</a>,” Fintech Ranking, December 2016.

Alexandra Rizzi, Isabelle Barrès, Elisabeth Rhyne, “<a href="http://www.centerforfinancialinclusion.org/publications-a-resources/browse-publications/916-smart-brief-tiny-loans-big-questions">Tiny Loans, Big Questions</a>,” Center for Financial Inclusion at Accion.

John Owens, “<a href="http://www.centerforfinancialinclusion.org/programs-a-projects/cfi-fellows-program/783">Responsible Digital Credit</a>,” Center for Financial Inclusion at Accion. Forthcoming, 2018.

George Ngigi, “<a href="https://www.businessdailyafrica.com/economy/Pain-of-Kenyans-blacklisted-for-amounts-as-small-as-Sh100/3946234-3374120-r0r2bfz/index.html">Pain of Kenyans Blacklisted for Amounts as Small Sh100</a>,” <em>Business Daily Africa</em>, September 2016.

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Start-Ups and Digital Innovation: Are Fintechs in Africa Over-Indebting their Customers?

Very small instant consumer loans have ballooned from 11 deployments in 2011, to 52 in 2016, with a particular concentration in East Africa. In just a few years, through models such as M-Shwari, M-Pawa, Tala and Airtel Money, tens of millions of people have borrowed tiny amounts over their phones. These services represent an enormous increase in formal financial inclusion. They address a fundamental consumer need previously unavailable to lower income people from the formal financial system: the need for very short term money management tools to cope with income and expense volatility. While they are in many ways a boon, they also contain, and in some cases heighten, risks for their users.

This Brief enumerates and discusses emerging consumer risks posed by these products, using the Client Protection Principles as an organizing framework. We hope this lens will assist the mobile financial sector to articulate and build a consensus about responsible practices in mobile finance.

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Tiny Loans Big Questions: Client Protection in Mobile Consumer Credit