Balancing access to digital lending with suitable law
Joseph Githaiga and Christopher Ndegwa
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 systems 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 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 June 19, 2020 as a privately sponsored bill by the fallen Bonchari Member of Parliament Oroo Oyioka.
The Bill has since been revised and published on November 30, 2020 as a privately sponsored bill by Member of Parliament Gideon Keter.
It seeks to give 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.
The Bill aims to introduce the requirement to be licensed by the CBK in order to transact as a digital money lender.
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.
The Bill also provides that the license issued by the CBK will be valid for a period of one year and may be renewed upon the licensee making an application at least three 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.
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.
A more apt regulatory model would be one that enhances consumer protection through 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. - Joseph Githaiga leads PwC Kenya’s Regulatory Compliance & Advisory unit. Christopher Ndegwa is a Senior Associate with the same unit.