Finance is the flow of resources through time and space, between individuals and organisations, so that members of the society can optimise managing day to day, mitigate risks and invest for the future. In an ideal market, this would happen seamlessly with everyone becoming better off.
The past two years have seen an increasingly alarmist conversation arising over the “Wild West” nature of the latest kid on the block — digitally delivered loans. The explosion of digital credit in Kenya since the CBA/Safaricom solution M-Shwari in 2012 has raised a concern in policy, financial sector development and consumer protection circles.
These largely legitimate worries centre around over-indebtedness, credit reference bureau (CRB) reporting of defaulters, high interest rates, lack of regulation, source of funding and other concerns. But the singular focus on the potential and real risks of digital credit could take our eye off the wider credit market, which has a much more significant impact on Kenya’s economy.
Financial credit involves the intermediation of resources (cash, goods or services) from those who have a surplus (savers) to those with a deficit (borrowers). Key conditions are that borrowers productively use the resources now to generate enough value and be willing and able to repay in future.
In simpler terms, credit is one way in which finance moves money through time.
The credit market, then, can be thought of comprising all the individuals and institutions who originate, package, structure, price, deliver, receive, use, monitor, repay, collect and report credit transactions. For the supply side (savers) in the credit market, the incentive to invest their money in this way is to earn a return while exposing their capital to as little risk as possible.
Although some savers (particularly those giving credit in the form of goods or services) decide to take on many of the functions of the credit market, most give up this right to intermediaries, for a smaller but surer return and more security of their capital.
The formal (un)regulated intermediaries include banks, saccos, microfinance institutions, risk funds, some investment groups, savings groups, financial service associations and development finance institutions. The informal ones include family and friends and “loan sharks”.
Various state regulators oversee the stability of the intermediaries and the safety of consumers — both borrowers and savers.
All these players face the problem of information asymmetry. At the outset, lenders have limited information about the borrower that would minimise the risk. Information is hard to come by and, more importantly, gathering it can be expensive and time-consuming.
This problem presents itself to borrowers as a “20-page” application form, endless requests for information, getting sureties and guarantors or the over-collateralisation (Sh1.5 million piece of land for a Sh200,000 loan).
Should the lender sense a mistake in judgement about a customer in the offing, overly enthusiastic collection, high fees, penalties and aggressive pricing (interest rates) are the consequence of return seeking — with the collective effect of credit rationing.
A direct result is a stunted regulated formal credit market and an equally robust but potentially extractive unregulated informal market, as exists in Kenya.
In countries with developed credit market infrastructure, credit markets have expanded by exposing the data of good and bad borrowers, enabling more appropriate collateral to be utilised and protecting borrowers and lenders with clear, complete and enforceable rules.
While Kenya has made strides in its credit market infrastructure, there is a lot to be done. The advancement of technology-enabled digital finance has given forward thinkers and innovators leeway to experiment with leapfrogging the pace of infrastructure development by creating alternative forms of credit on digital platforms.
As new digital lenders come to market each month with varying degrees of success, and calls increase from far and wide to control, regulate, protect or treat small borrowers differently, remember that this is just the latest form of credit, that digital credit is essentially a delivery tool in a larger credit market.
Despite the many issues that plague nascent digital credit, innovation in the credit market is about reducing uncertainty and transaction costs brought about by information asymmetry.