One out of seven Kenyans now regularly borrows money using their phones to settle personal and business needs, thanks to expansion of digital credit, which basically refers to borrowing and lending of money using a mobile phone, Internet or a digital app.
A digital loan is money advanced by a lender and repaid by the borrower entirely on a digital channel. Digital credit providers (DCPs) have gained popularity owing to the convenience they offer borrowers. Loans are disbursed almost instantaneously without the hassle of paperwork or collateral.
A 2018 survey by Financial Sector Deepening (FSD) Kenya revealed that more Kenyans are now resorting to borrowing from DCPs compared to traditional loans from banks. However, the impressive growth in digital credit has come with many challenges. While the bulk of digital loans – 97 per cent – are advanced by regulated entities like banks and telecommunications firms, it is the predatory practices of some unregulated DCPs that have raised concerns.
Some of the predatory practices include high cost of loans, illegal sharing of personal customer data, and unethical debt collection practices. For example, some lenders have resorted to shaming loan defaulters by contacting their friends and relatives or even threatening them with violence if they do not pay.
There was also concern that some digital credit platforms could be conduits for criminal activities like money laundering and financing of terrorism. Without proper regulation, it is easy for organized crime cartels to move illicit funds through the financial system using such platforms. Besides being detrimental to customers, such practices pose obvious risks to the financial system.
But with the recent enactment of the Central Bank of Kenya (Digital Credit Providers) Regulations 2022, the digital credit market is set for a major shakeup. The new rules not only provide a robust framework for streamlining the fast-growing sector, but also to protect consumers from unscrupulous methods used by rogue lenders who have been exploiting Kenyans.
The regulations are anchored on the Central Bank of Kenya (Amendment) Act 2021 that came into force on December 7, 2021, the first step in giving CBK powers to regulate digital lenders. The Act required CBK to pass rules regulating DCPs within three months, which it did this month, within the time set by the Act.
The need to regulate DCPs has been a discussion going on since 2016. Attempts at self-regulation of the sector appear not to have yielded much impact by way of taming rogue elements in the industry. To its credit, the Digital Lenders Association of Kenya has made strides in instilling best practices in lending and especially consumer protection.
In addition, the Competition Authority of Kenya (CAK) has had to frequently intervene by invoking the provisions of the competition law regarding consumer protection, for instance, ensuring transparency in product pricing and preventing unconscionable conduct by digital lenders.
The new CBK regulations therefore represent a new dawn for digital lending in Kenya. First, any person seeking to carry out the business of providing digital credit must now be licensed by the CBK. Existing DCPs other than banks and telecommunication mobile money services must apply to CBK for a license within six months, that is, by 17th September 2022. (The CBK regulations came into effect through Legal Notice No. 46 dated March 18, 2022).
Mandatory licensing will help weed out rogue players and restore sanity to the industry. Also, applicants for a DCP license will have to comply with tough requirements including providing critical information including their sources of funding, identity of significant shareholders, and procedures for preventing money laundering and financing of terrorism.
Notably, only companies and unincorporated associations can apply for a license meaning individuals are barred from carrying out digital credit business, sounding the death knell for shylocks masquerading as digital lenders. Licensed DCPs will be obligated to file annual returns with the CBK which must gazette names of all licensed providers by March 31 every year.
Second, the new regulations provide clear corporate governance guidelines based on integrity, ethics, sound risk management, and good reputation and legitimacy, thus infusing much-needed best practice across the industry.
Critically, significant shareholders, directors and senior management must meet the ‘fit and proper’ test as set out by CBK for them to be approved. Any changes in significant shareholding or senior management must be approved by CBK to prevent any attempt at circumventing compliance with the ethics and integrity provisions. DCPs must also satisfy the CBK that the cash invested in the business is not part of proceeds of crime. They must also strictly comply with the provisions of Proceeds of Crime and Anti-Money Laundering Act 2009 and the Prevention of Terrorism Act 2012.
Third, the rules provide mechanisms for consumer protection including prohibiting the sharing of confidential customer data with third parties without consent of the customer. This will help eliminate dissemination of adverse information calculated to embarrass or coerce the customer in the event of failure to settle their debt.
DCPs are now required to provide all information regarding a loan product to enable the customer make an informed decision. Any variations of the loan amount, charges and interest rate must be communicated to the customer at least 30 days before any such variations are effected. This will protect consumers from unilateral, unconscionable conduct by lenders.
Fourth, to address the public hue and cry over unethical practices like debt shaming, the rules prohibit the use of violence, threats and obscene language in recovering outstanding money from borrowers. Criminalizing such behavior will enhance the customer experience and encourage lenders to develop better credit risk profile tools.
DCPs can only share customer credit information only where reasonably required to discharge their functions, and in case of negative credit information, only for amounts exceeding Ksh. 1,000. However, they must inform the customer of their intention to share credit information with credit reference bureaus not less than 30 days before doing so.
In case of default, digital lenders are only allowed to recover the principal outstanding at that time, interest on the principal but not exceeding the principal owing plus reasonable expenses in providing the service. This will help curb usurious demands by unethical lenders seeking to cash in on the misery of borrowers who are unable to service their loans.
Breach or any violation of the regulations will attract severe penalties and administrative sanctions including suspension or revocation of the license and criminal prosecution.
Having a regulated digital lending market is a major boost for financial inclusion in Kenya. At the heart of digital credit is providing an avenue for the millions of Kenyans locked out of the formal credit market to access loans to build their lives and businesses. However, this must be done within a transparent, ethical and safe environment for consumers.
Mr. Choto is a legal and policy analyst. Email: email@example.com