The Unforeseen Consequences of an Innovation Boom in Kenya

Team Leader: Katrina Marsden

Primary Contributor: Brandon Chang 

Risks:

Kenya’s capitalist and market-driven economy has created a strong opportunity for financial technology companies to serve the population with enhanced products and services. Rapid innovations are occurring in a multitude of domains (see Exhibit 1). [i] The payments/money transfer and lending services are at the greatest risk because of lagging regulatory action and potential credit default among consumers. Banks are legally required to cap interest rates at four points above the central bank’s interest rate.[ii] Because of the weak regulations for digital lenders, particularly on microloans throughout East Africa, interest rates can be several hundred percent, thereby reducing the effectiveness of financial technology companies in generating financial-inclusion among Kenyans.[iii]  Barclays Kenya, Safaricom, and Tala offer digital loans with an annual interest rate of 84%, 90%, and 180% respectively.[iv] Therefore, investors in this space should seek to have a deep understanding of liquidity and credit risk within the Kenyan market. The most reliable customers for businesses will be those with high financial literacy rates that understand the debt they hold.

Despite the poor regulatory framework currently in place, the increasingly competitive pressures facing traditional banking institutions has created some world-leading technology, thereby elevating customer expectations. With the growing demand to maintain market share, banks can longer afford to remain stagnant. M-PESA is a mobile-money system developed by Safaricom that allows users to transfer money between peers and to businesses after physically depositing cash to one of the 40,000 agents.[v] The low-cost option to move money also offers loans and savings products. With over twenty million Kenyan users, M-PESA has led to several start-up competitors who aim to take market share.

The proliferation of more than 50 other digital credit lenders however, has led to overborrowing, hardship among Kenyan people, and financial-exclusion.[vi] 2.7 million people were negatively listed on Kenya’s Credit Reference Bureaux within the last three years.[vii] For digital credit lenders who do not invest resources in distinguishing customers with strong credit from weak credit, or whose risk appetite is exorbitant, their success will be short-lived. A data analysis of more than twenty million digital loans conducted by the Consultative Group to Assist the Poor found that less than 40% were for financing a business. Some suggest that a growing number of individuals are taking out loans to gamble online.[viii] Without controls in the Kenyan credit market to create a stable system for financial technology start-up companies as well as banks, there is a looming possibility that the country replicates the same mistakes made in South Africa. In 2014, the banking system collapsed because of unrestrained lending, leaving household debt exceptionally high.[ix] Preventative measures are needed to keep the market healthy in the near and far future with consumer activity, and to incentivize further innovation through research and development.

Mitigation:

Two solutions can address the risks noted. The first is regulatory sandboxes. Regulatory sandboxes are temporary relaxations or adjustments to regulations that provide a “safe space” for companies to test new products, specifically for technology-based financial services. The sandbox will mimic the production environment in real-time and stimulate consumer responses. It allows banks and fin-tech companies to test their pilot product and contain the consequences of their failure.[x] If this is done consistently with new market entries, it will prevent the excessive increase in complex financial products and services being sold to Kenyans uneducated on what they are using. In addition, the government will need to control interest rates to maintain comparable competition between traditional banks and financial technology firms.

The second way in which banks, financial technology companies, and the Kenyan government can reduce credit risk to the economy, consumers, and businesses is through more thorough credit assessments. Financial technology companies have the opportunity to develop innovative solutions in this space by creating algorithms that allow banks to check financial activity, in addition to other data sets obtained from phone usage.[xi] This could include location tracking to confirm a stable job, general spending habits, and potentially even browser information. Overtime, the algorithms will be able to identify credit worthiness with a greater degree of accuracy.

 

[i] Mbogo, Angeline. “Kenya’s Fintech Market Needs Combination of Regulatory Sandbox & Helpline to Thrive – FSD.” The Kenyan Wallstreet, https://kenyanwallstreet.com/kenyas-fintech-market-needs-combination-of-regulatory-sandbox-helpline-to-thrive-fsd/.   

[ii] Fick, Maggie and Mohammed, Omar. “Kenya moves to regulate fintech-fuelled lending craze.” Reuters, https://www.reuters.com/article/us-kenya-fintech-insight/kenya-moves-to-regulate-fintech-fuelled-lending-craze-idUSKCN1IQ1IP.

[iii] “Borrowing by mobile phone gets some poor people into trouble.” The Economist, https://www.economist.com/finance-and-economics/2018/11/17/borrowing-by-mobile-phone-gets-some-poor-people-into-trouble.

[iv] Fick and Mohammed, Reuters.

[v] “Why does Kenya lead the world in mobile money?” The Economist, https://www.economist.com/the-economist-explains/2015/03/02/why-does-kenya-lead-the-world-in-mobile-money.

[vi] “Borrowing by mobile phone gets some poor people into trouble,” The Economist.

[vii] Fick and Mohammed, Reuters.

[viii] “Borrowing by mobile phone gets some poor people into trouble,” The Economist.

[ix] Fick and Mohammed, Reuters.

[x] Mbogo, The Kenyan Wallstreet.

[xi] “Borrowing by mobile phone gets some poor people into trouble,” The Economist.