See you in court? Unlikely. In recent times most law courts in Africa have not been suitable places to enforce or defend low-value retail credit contracts – the transactions costs associated with the legal process swamp the value of most claims.
A lender usually only goes to court in order to establish a precedent or achieve a selective demonstration effect to encourage other defaulters to pay. The situation is even worse for small borrowers, who cannot afford to defend themselves against deep-pocketed financial institutions. Some countries, including the US and South Africa, have established small claims courts, which cut away some of the legal red-tape for low-value suits, and allow for self-representation. Legal insurance offers to pay for a lawyer if you get into trouble – and has become quite popular in South Africa, a country with a hyper-active consumer credit sector and, as a result, all the associated legal issues.
However, the sheer scale of the growth of digital lending in the developing world will swamp all such efforts to make up for fundamental failings of the court process. In Kenya, over 2.8m people have accessed small loans, many for the first time, using mShwari, the mobile loan product. The very latest evidence, from FinAccess Kenya 2016, shows that the proportion of Kenyans who have used formal sector credit has jumped as a result: 5.9% of the adult population report using a mobile bank account loan (up from 0% in 2013, when mShwari had barely started). It is now the largest single usage, formal credit product—more than SACCO loans, for example.
This growth is not confined to Kenya. Across the continent, digital lending models based on new data and methodologies are making formal credit available to previously excluded adults. Whilst this offers great potential, it also brings with it new risks and regulatory challenges.
It is time for financial services to learn lessons from the growth of e-commerce globally. Much of this growth in online transacting came in advance of clear legal frameworks to protect buyers or sellers. But, recognising the need to build and preserve trust in the system for both parties, leading e-commerce marketplaces like eBay have built large and efficient e-arbitration systems. These systems allow for participants to file a claim online, which is then processed automatically, in most cases based on underlying data about the transaction itself and the reputations of the parties established through their transaction patterns. As a result, the claims can be handled quickly and at a cost which the e-commerce platform can absorb out of its margin. Of course, not all claims can be resolved without human intervention, but limiting human intervention to the exceptions, or the appeals, can vastly reduce the workload and the cost.
Of course, though arbitration may be more efficient than courts, it may not always be fair as it is subject to less oversight and transparency than the public court system. The US Consumer Financial Protection Bureau recently criticised some providers for their ready recourse to arbitration (not necessarily e-arbitration), in ways which would prejudice borrowers’ rights.
Despite these potential issues, developing robust e-arbitration systems seem to be the only way to ensure that credit disputes in the digital era can be settled with fairness, efficiency and cost-effectiveness. The role of the state needs to be redefined – perhaps as accreditor and monitor of different arbitration platforms, rather than provider of the court process.
Who pays also needs to be clarified – but there is a good case to build the cost into a small levy on all small loans since, both borrowers and lenders will ultimately benefit. With enough information about the history of the borrower (and lender), insurance schemes could be overlaid with the process. If the reason a borrower cannot pay is because of death or protracted illness for example, the debt could be settled from a fund or platform-wide insurance mechanism. Offering such insurance across multi-lender arbitration platforms, leveraging the law of large numbers, may be cheaper and fairer.
In the absence of such recourse mechanisms, trusted by both borrowers and lenders, digital credit may well end up as a grey market product, prohibitively priced by lenders because they know that small loans cannot ultimately be legally enforced, with borrowers gaming the system because they cannot be held accountable. There are some encouraging signs that Kenya may be exploring this direction. If something like this is not implemented relatively soon, as the market expands, it may be too late to set a path towards healthy consumer credit markets, rather than a system which entrenches conveyer-belt like credit churn.
Credit on the Cusp is a project of FSD Africa that studied the credit market experiences of urban cuspers in Ghana, Kenya, and South Africa, using insights from their stories to help build a new vision for healthy credit market development in sub-Saharan Africa. The full report will be published 8 September 2016. For more information see: http://www.fsdafrica.org/credit-on-the-cusp/.