The new value proposition of tech enabled microloans
The dizzying growth rate of some digital-micro-loan (DML) products raises the question: are they the new microcredit to the poor? Serving low-income clients with low value credit wasn’t an attractive value proposition for most formal financial institutions (FIs). MFIs were among the few that honed the skills to serve them, though doing so requires a costly high touch method. But tech-enabled micro loans can be offered instantly through low touch service at a lower cost, making them an attractive proposition and heating up competition as new players enter the market.
M-Shwari (2012) and KCB M-Pesa (2015) are both bank-Safaricom partnerships that provide DMLs. In Kenya, they have recently been joined by Equity Bank (2016) which offers Eaazy loans through its own Telco. They are part of a larger trend steadily transforming micro-credit markets. Kenya is a good case study since it has one of the most evolved ecosystems for digital financial services. Kenyans trust mobile money, 67% have a mobile money account (and 72% of them are active users), and 42% use advanced services beyond transfers and air top-ups (InterMedia, FII 2015).
The underlying risk management strategy of these loans harks back to an older microfinance model: mandatory savings for access to credit. The new tech version also requires the use of an algorithm based on a client’s use of Telco services to assess their ability and willingness to repay. Loan servicing costs are lower because after the initial account registration, you don’t have to meet your client to evaluate or serve individual loans; an agent does cash in-cash out.
Who is served by the new DMLs?
M-Shwari had 10 million clients within 2 years, KCB M-Pesa attracted 5.2 million clients in 1 year and Equity has already had 1.7 million borrowers in its first 6 months. Lower income clients tend to have irregular incomes and are routinely in need of short-term micro loans for consumption smoothening and emergencies. These digital micro loans seem like a perfect fit for use in such cases, particularly in Kenya where they are already users of mobile money. Are M-Shwari, KCB-Mpesa and Equity serving these lower income clients? It does not look like it - yet.
InterMedia’s FII program has been tracking data on M-Shwari since 2013. They find that 32% of mobile money users used M-Shwari in 2015; an increase from 12% in 2013 (equivalent to 10% of all adults). Most M-Shwari users are educated, professional men between the ages of 15 and 34 who live above the poverty line. Two-thirds have a bank account but use M-Shwari as an enhanced banking experience - since savings, lending and transfers are all offered on one convenient mobile platform. The number of users below the poverty line has actually decreased from 30% in 2013 to 22% in 2015. We still don’t have data on user profiles from Eaazy and KCB-Mpesa.
Are DMLs the future of growth in the microcredit sector?
Despite the high growth rate, DMLs currently appeal to a narrow segment and don’t yet reach the poor. Maybe - despite the benefit of credit provision - they don’t trust the service enough to save with mobile money? It remains to be seen whether the low touch approach to DMLs offers the right model for serving poor or excluded client segments. Or are these terms not attractive to them?
Digital loans have generated large profits for Kenyan banks by effectively charging a 60%-100% interest rate. Though building mobile infrastructure is expensive, these rates are also very high. The Central Bank of Kenya’s Banking Act 2016 placed a cap on interest rates for such loans at 14.5%. While Equity has already re-set the interest rate, CBA and KCB are fighting this cap. If regulators continue to apply banking rules without proportionality and implement interest caps, it might discourage innovation.
The digital channel itself continues to hold promise due to its cost-cutting function and ease of use, at least for those with financial capability and digital literacy. But providers have to refine their strategies to digitize and/or create partnerships that leverage digitization for efficiency and effective client engagement in a new ecosystem. Digitization cannot completely replace high touch service provision, especially in order to reach lower income clients. Therefore, providers have to balance a combination of high-touch and low-touch options to provide efficiency and usability that match clients’ needs.
Will a provider like Equity, that already serves a broad client base that includes lower income clients, be more successful by providing both high and low touch options? Will bank-Telco partnerships that use the mobile platform as a distinct business model, separate from their core banking operations, manage to stay viable? Or are both equally likely to succeed by serving different client segments?