Why registering digital lenders may outweigh licensing regulation

By People Daily
Friday, July 16th, 2021 00:00 | 3 mins read
mobile money
Co-op Bank has announced that it will retain interest rates on outstanding loans following repeal of interest rate cap. PHOTO | COURTESY


Small businesses and households had very limited access to banks a decade ago, however, they can now get credit in seconds without physical interaction or paperwork.

Everything  has moved to the internet amid rapid growth of digital lending, bringing an alternative financing model to cure hurdles of traditional brick and mortar lending models.

Businesses are  nowassured of cheaper and flexible instant loans to sustain operations, increase stock and shield households from sliding into distress during emergencies.

The popularity of mobile lending apps has however piled pressure on the need to regulate the fast rising financial technology (fintech) sector.

Different opinions have emerged regarding how the nascent sector should be regulated.

The government, through the proposed Central Bank of Kenya (Amendment) Bill, 2021 is pushing for a licensing regime to weed out rogue digital lenders and bring sanity in the market.

Micro-credit lenders on the other hand have been campaigning for a different model which entails registration, saying it is the best model to support growth of the sector and promote innovations.

However, what must be encouraged is a progressive regulation regime, to guide the sector to be a powerhouse in Africa and bolster financial inclusivity in Kenya.

While regulating through licensing is an option, the time is not just right. The size of micro-credit providers and their target clients will not allow the licensing regime intended results.

Therefore, we should consider a licensing registration regime. Using a licensing regime to regulate a nascent industry such as non-deposit taking digital lending space is that rules on minimum capital requirements, financial adequacy, reporting, local shareholding requirements and so on, would impose significant compliance costs.

Lean startups

Most unregulated digital lenders in Kenya are lean startups, which are funded by shareholder or investor funds.

Onerous compliance costs and bureaucracy would affect the viability of these entities, stifle innovation and rob consumers convenient and reliable means of accessing finance.

Capital adequacy is unnecessarily onerous to the model of digital lending (B2C) that can be used in Kenya under the current laws.

Currently, section 3 of the Banking Act, chapter 488 of the laws of Kenya (the “Banking Act”) restricts persons from carrying on banking business unless they are a licensed bank or are carrying out the business on behalf of a registered bank.

Banks accept deposits from members of the public and deploy the deposit by lending, investment or any other means to earn.

Capital adequacy is important in the regulation of banks and other deposit taking institutions. Banks can loan a significant amount of deposits to third parties but will legally be liable to pay the customer on demand.

As such, banks need to have enough capital to absorb a considerable number of customers, while demanding payment at the same time.

It is for this reason that capital adequacy is important for the stability of deposit taking institutions.

Non-deposit taking digital lenders, however, lend money that they hold at their own risk.

As such, regardless of their capital to risk-weighted assets ratio, they will not pose a risk to the public as any losses they might incur will be subject to a commercial agreement with their shareholders and investors.

This view has been taken by most jurisdictions globally. PricewaterhouseCoopers (PWC) early this year cited six cases, saying where there was regulation around capital, the regulation was centred around minimum capital required to start business. Not on the capital adequacy as is suggested by the proposed amendment.

Capital adequacy ratios

Further to the capital adequacy ratios, liquidity ratios will be punitive to non-deposit taking lenders.

While it is paramount CBK protects depositors by ensuring that licensed banks and other deposit taking financial institutions have sufficient funds to meet their financial obligations, it is not the duty of the CBK to monitor liquidity in transactions that pose no risk to the public.

Digital lenders will ordinarily finance their loans by a mix of equity and commercial loans, that is, arm’s length transactions conducted by sophisticated investors aware of the risks of their business activities.

The business model operated by non-deposit taking institutions does not require any repayment of deposits on demand, as is required by financial institutions such as banks and deposit taking micro-finance institutions.

The basic requirement for operating a digital credit business should be registration of the entity with a registry that would be managed by CBK. This would allow the regulator keep a record of such lenders for purposes of supervision.

A digital version of the register should be maintained and should be accessible online to allow potential borrowers to do their due diligence in an easier manner before taking up a facility with a digital credit provider.

In the spirit of togetherness, we look forward to quickly establishing the EAC as a trade, investment and industrialisation hub, more so, as we open our borders to the continent through AfCFTA.

This is the one true path towards regional integration, aiding development and enhancing productivity. — The writer is the Managing Partner of ECM Consulting Group, LLP

People Daily