Balancing access to digital loans with appropriate regulation

The Bill also seeks to introduce to the CBK Act a new section on the licensing of mobile money lender platforms.

In Summary
  • The loan amounts are typically low value and short tenor
  • Digital credit involves limited in-person contact and leverages digital infrastructure.
Tala app, an online financial micro lending platform is seen on a mobile phone in this photo illustration taken May 23, 2018. REUTERS/Thomas Mukoya/Illustration
Tala app, an online financial micro lending platform is seen on a mobile phone in this photo illustration taken May 23, 2018. REUTERS/Thomas Mukoya/Illustration

Increasing access to credit is an essential aspect of Kenya’s efforts to accelerate economic growth.

Over the last several years, new digital lending platforms have provided access to credit for those who were previously excluded from formal financial services.

Those platforms have proved to be popular as most Kenyans, prior to the introduction of digital credit, relied on informal lenders and their social support system for low-value short-term credit.

Digital credit involves limited in-person contact and leverages digital infrastructure.

The product relies on digital infrastructure to receive loan applications, determine the creditworthiness of borrowers, approve the loan, disburse the funds and receive payment.

The loan amounts are typically low value and short tenor (ranging from a few days up to a month).

It is indicative of the maturity and systemic importance of the digital lending industry that the Central Bank of Kenya (Amendment) Bill, 2020 (the Bill) was first published on 19 June 2020 as a privately sponsored bill by Member of Parliament Oroo Oyioka.

The Bill has since been revised and published on 30 November 2020 as a privately sponsored bill by Member of Parliament Gideon Keter. The Bill seeks to give the Central Bank of Kenya (CBK) the mandate to regulate digital money lenders by introducing licensing requirements.

To date, the industry’s self-regulation has been coordinated through the Digital Lenders Association of Kenya. The Bill indicates that formal regulation by CBK is now necessary, over and above self-regulation.

The Bill seeks to introduce the definition of a ‘digital money lender’ to refer to an entity that offers credit facilities in the form of mobile money lending applications. The Bill also seeks to introduce to the CBK Act a new section on the licensing of mobile money lender platforms.

Expanding CBK’s scope

The Bill aims to introduce the requirement to be licensed by the CBK in order to transact as a digital money lender.

Such an application for licensing is required to be accompanied by a number of other documents such as a copy of the company’s memorandum and articles of association, a verified official notification of the company’s registered place of business, the prospective place of operation and prominent terms and conditions of the mobile lenders before activation of mobile loan accounts among others.

Interestingly, the Bill proposes minimum capital requirements for digital money lenders – a prudential regulatory requirement common with deposit-taking institutions.

Such a requirement may serve as a barrier to entry for non-deposit-taking digital lenders and may have the effect of reducing competition in the industry.

The Bill also provides that the license issued by the CBK will be valid for a period of 1 year and may be renewed upon the licensee making an application at least 3 months prior to the expiry of the license.

The CBK will also have the runway to prescribe any other additional requirements it may deem fit and may issue a conditional license to an applicant under any conditions that it deems necessary. It is not clear what such conditionality would entail.

From a governance perspective, the Bill requires that every digital money lending institution be managed by at least 2 directors. It is not clear the rationale to have at least two directors as Kenyan company law allows for single directorship in companies.

The drafters of the Bill may consider prescribing certain minimum qualifications that directors of digital money lending institutions ought to have as this would ensure technical competence in the decision-making of these institutions.

Further, the Bill provides that every foreign-owned digital money lending institution ought to have at least 1 director that is a Kenyan citizen.

The Bill also requires digital money lenders to expressly announce their interest rates when advertising their services. This is in line with consumer protection principles of transparency to provide customers with sufficient pre-contractual information such as the interest rate applicable on a loan and any other associated fees.

A different regulatory approach

Specific regulation of digital lending does not appear to be common in most markets across the globe. Most countries do not have a regulatory framework that distinguishes between digital lenders and traditional non-deposit-taking microfinance institutions (MFIs).

This is because ‘digital lenders’ are simply non-deposit-taking microfinance institutions that advance credit through digital applications as seen in Kenya.

As is the case with non-deposit-taking MFIs, these require some form of licensing to operate. In Kenya, the CBK currently issues a letter of no objection approving the operations of a non-deposit-taking MFI whether they are a digital lender or operate a brick and mortar lending institution.

Several countries have licensing as a core feature of the regulatory framework in relation to digital lenders, which implies that governments see licensing as an effective means of enforcing supervision in the financial services sector.

However, a country such as Poland illustrates that licensing may not be necessary where there is an effective consumer protection regime that can be enforced against lenders by a supervisory agency such as the consumer protection and competition regulator.

The concern with using a licensing regime to regulate a nascent industry such as non-deposit-taking digital lending is that stringent rules on minimum capital requirements, financial adequacy, reporting, local shareholding requirements and so on, would impose significant compliance costs on participants.

The licensing approach that the Bill proposes of having minimum capital requirements is ideal in prudential regulation of deposit-taking institutions such as banks and other deposit-taking MFIs.

However, given that a majority of digital money lenders are non-deposit taking MFIs who finance their operations from privately sourced funds, it would be unfair to subject them to prudential regulation such as having in place minimum capital requirements as they are not using publicly sourced funds (depositors’ funds) to finance their operations.

Given that the mischief that Kenyan regulation is seeking to address is effective consumer protection, the focus ought to be on the implementation of a consumer credit code that will protect consumers of credit rather than restricting the provision of credit to those who may otherwise not have access to capital.

From a consumer protection perspective, it is best practice to require transparency in the information provided to prospective borrowers.

Currently, the Consumer Protection Act and the Competition Act require that lenders provide sufficient pre-contractual information to borrowers to enable them to provide fully informed consent to the terms and conditions associated with the loan being advanced.

However, it is important to note that these statutes are not designed to regulate consumer credit comprehensively notwithstanding that they may have some provisions dealing with the subject matter.

Specific legislation that regulates all providers of consumer credit that are currently not regulated would be ideal in this regard. Such specific legislation may take the form of a consumer credit code that would also allow the CBK to enforce provisions of consumer protection and guide the conduct of consumer credit providers.

A similar approach has been adopted by Australia that has in place a National Consumer Credit Code which provides a consumer protection framework for consumer credit products.

Such a framework is advisable as it balances between the viability of the business for the lenders and the interests of the borrowers.

Final thoughts

In light of the emerging nature of the non-deposit-taking digital lending industry in Kenya, a complicated licensing framework specific to the digital lending industry may stifle its growth and deny Kenyan individual, micro and small enterprise consumers an important source of access to finance.

A more appropriate regulatory model would be one that enhances consumer protection through the regulation of the conduct of consumer credit providers (digital lenders and others).

This can be achieved through the development and enactment of a consumer credit code that embeds the principles of consumer protection in lending.

All non-deposit-taking providers of credit to the public, regardless of their business model, would be bound by a set of consumer protection principles. This may be an ideal way of achieving the objective of regulation of digital lenders as envisioned in the Bill.

The enforcement of such a consumer credit code should be vested in a regulator such as the CBK or another agency with a strong consumer protection mandate (for example, the Competition Authority).

The code should provide for registration, but not necessarily licensing, of consumer credit providers (including digital lenders) to make it easier for the relevant regulator to monitor their conduct and take enforcement action in the event of a violation of the code.

With respect to dispute resolution, some countries have introduced administrative agencies to handle and resolve consumer complaints against consumer credit providers.

For example, Poland and the UK both have Financial Ombudsmen. Such a dispute resolution mechanism ought to be considered for Kenya to assist with the resolution of consumer disputes with consumer credit providers, particularly where the disputes do not warrant more complicated and expensive dispute resolution options such as litigation.

The Ombudsman would liaise with the CBK particularly with respect to serious or sustained violations of the code by a consumer credit provider.

That said, Bill’s overall effort to regulate Kenya’s digital lending industry is helpful insofar as it addresses some of the limitations of self-regulation.

At the end of the day, the Bill ought to demonstrate stakeholder consultation and pave the way for closer collaboration between different existing regulators and supervisory organisations.

Whilst a lack of well-defined consumer-centric regulation clearly disadvantages digital lending consumers, it could also cripple the digital lending industry in the long-term and thereby deny access to credit for those who need it.

Joseph Githaiga leads PwC Kenya’s regulatory compliance & advisory unit. Christopher Ndegwa is a senior associate with the same unit.