Why Fintech lending could push the poor into debt trap

In January 2019 Kenya’s telecoms giant Safaricom launched Fuliza M-Pesa, a lending platform hinged on the original cash transfer and bill settlement product, M-Pesa.

The uptake was phenomenal. Lending reportedly hit Sh1 billion in one week. By month end, total lending stood at Sh6.2 billion.

Given the financing gap in Kenya, the development of Fintech should be a good thing but for three things; low levels of financial literacy, the rise in household indebtedness, and lack of regulations.

In 2014, the Standard & Poor’s Rating’s Services conducted a global financial literacy survey. The survey examined four financial matters: interest rates, interest compounding, inflation and risk diversification.

The survey put financial literacy rate in Kenya at 38 per cent, on average.

Averages are misleading though. Financial illiteracy is much lower among women, youth, the poor and rural dwellers who form a sizeable share of Fintech clients.

The respective proportions of the extremely poor, women, youth, and rural dwellers in Kenya is 36.1 per cent, 50.3 per cent, 80 per cent, and 73 per cent, according to the World Bank, reflecting the spatial frequency of financial illiteracy.

Low financial literacy limits the benefits that clients derive from the access and use of financial services.

Annamaria Lusardi and Olivia Mitchell of NBER show that people with higher financial literacy plan their jobs well and save more for retirement. Moreover, financial literacy improves the capacity to manage risk through diversification and hedging.

By contrast, low financial literacy manifests in the form of greater financial transaction fees, higher interest payments on loans, and, consequently, overindebtedness.

Already, social commentators have raised concern regarding the rise of household indebtedness in Kenya.

Tellingly, the number of Kenyans, particularly the youth, listed negatively by credit reference bureaus has risen by over 2.7 million between 2015 and 2018, according to MicroSave.

In India and Nicaragua, poor people have protested overindebtedness, and aggressive debt collection drives by microfinance institutions, which gives credence to these claims.

The apprehension regarding Fintech lending rotates around excessive interest rates, raising an ethical concern about the existence of a “poverty penalty”.

The risk of poor people falling into an unsustainable debt cycle heightens when we factor in the financial decision making criterion that they follow.

The more affluent investors borrow to fund a project whose return is at least the rate of interest on the loan.

Such a project would generate enough revenue for loan repayment and leave a surplus for the project owners.

This model dominates the finance courses taught in tertiary institutions.

However, researchers have noted that the poor people place a premium on survival over the maximisation of output and profits.

The indigents raise their chances of survival by emphasising shared roles, engaging in varied economic activities, and favouring economic processes over outcomes.

Hence, regardless of the cost, an indigent person would take up a microloan to allow them to survive another day.

It is common to find an individual juggling multiple loans from multiple lenders.

Besides, the poor have a shorter planning horizon compared to the rich. Thus, the poor do not necessarily use the annualised interest rate as a criterion for financial decision making.

Thus, given the conditions of poor people, it is easy for unethical firms to take advantage by overcharging on interest. Currently, Fintech firms operate outside the interest rates cap.

Taken together, poverty and financial illiteracy form a self-reinforcing cycle that may worsen the debt burden and hence, the conditions of the poor.

Regulations could mitigate some problems posed by Fintech. However, the evolution of the regulatory frameworks tends to lag the advances in technology across the globe.

In Kenya, Fintech has taken root in a financial regulatory vacuum. Fintech firms are having a field day. The Central Bank of Kenya governor, Patrick Njoroge, has equated some Fintech lenders to shylocks due to their real or perceived engagement in predatory lending practices.

Financial sector regulation serves three core purposes — to sustain systemic financial stability, to maintain the safety and soundness of financial institutions, and to protect consumers.

Crafting regulations to protect the indigent, vulnerable population with low financial literacy is a legitimate, and essential pursuit. To this end, the finance ministry has already developed a draft bill on Fintech.

If Fintech firms are predatory, it is also due to limited competition, high operating costs of serving poor borrowers, and the high risk of default.

The onus is on the government to design mechanisms that allow the poor to access finance from alternative sources at affordable rates.

The sharing of credit histories of clients through credit bureaus and public credit registries is one such strategy.

But in Kenya, banks are yet to utilise credit history to determine interest rates on loans.

Moreover, the government should give incentives to micro-loan firms to mitigate the high costs associated with the administration of small loans to the indigent that pushes up interest rates.

Also, the government needs to emphasise programmes that target the poor by placing more financial and real assets in their hands.

Finally, efforts should be made to run financial education programmes, and include financial literacy content in school curricula.

Karuitha is a PhD candidate at the Business School, University of the Witwatersrand, Johannesburg and teaches finance at Karatina University. [email protected]