Consumer Protection in the Digital Lending Era

“It is difficult to serve all my customers with the small amount of cash or e-float I have in my till, and I often struggle to buy supplies for my shop”. This is the voice of a retail shop owner named Emu1, one of the many small business owners operating in Ethiopia’s capital, Addis Ababa. While this may be the case for Emu or others in the capital, the problem is similar for other MSMEs in other parts of the country. The recently announced partnership between Ethiopia’s largest bank, the Commercial Bank of Ethiopia, and Ethio-telecom’s Telebirr service is music to the ears of these MSMEs who have struggled to access funds from financial institutions in the country.

MSMEs in Ethiopia are mainly served by Microfinance Institutions (MFIs) as they are considered a riskier investment by commercial banks. MFIs usually struggle to meet the demand due to the challenges of inadequate loanable funds. With an estimated number of 1.5 million, MSMEs in Ethiopia are the main sources of employment (~4.5 million people) and income, contributing significantly to the local, regional and national GDP. According to research2 conducted to assess the impact of COVID-19 in 2020, over 65 percent of MSMEs responded that they would like to see policy changes to help them access business loans. Although their contribution to the national GDP is significant and forms a critical component, the lack of working capital hinders MSMEs from growing and becoming self-sustaining. Capital is a major challenge faced by MSMEs in the country, both for day-to-day operations and for scaling their businesses.

The partnership3 between the Commercial Bank of Ethiopia and Telebirr is not the first of its kind. More and more microcredit services are available in the market. Telebirr has previously partnered with Dashen Bank for example, for similar services. The Cooperative Bank of Oromia has been providing microcredit services to MSMEs through its Michu platform where it has disbursed to over 100,000 businesses a value of over ETB 1.3 billion (USD 23.5 million in a short period of time. Dashen Bank has also launched a ‘buy now and pay later’ scheme through a digital platform with its ‘Dube Ale’4 product. Similarly, another bank, Lion has launched its ‘Alegnta’ micro loan product, uncollateralized digital loan product with a dedicated budget value of ETB 500 million (USD 9 million).

This is a good start to solving the problem of working capital for MSMEs or individuals on a larger scale, but there is a great need for collaboration and information sharing to avoid challenges that come with digitally enabled credit products. The Kenyan market is an example where Ethiopian service providers and regulators can learn about, for example, consumer protection mechanisms. These mechanisms were put in place to respond to the high rate of over-indebtedness in the country, due to multiple loans taken by customers from different digital lending providers.

Most of the service providers were unregulated and the government is now taking measures to control the damage. One of the measures is to suspend all credit listings for loans that are below KES5 5 million (USD 33k) against the regulation which forbids listing any loan below KES 1,000 (USD 6.7). In addition to the limitation on the listing, hefty penalties were introduced for those organizations that either deny service for those that are registered as defaulters or for those that do not serve according to the regulation. The government also required all digital lending platforms to register with the regulator, as per the new regulation that required digital lenders to get permit from the Central Bank of Kenya (CBK) before launching their products6. In addition to this, Google7 also removed hundreds of lending apps from the Kenyan market. All these changes are being implemented to protect consumers, and industry players are calling for a more focused approach to protect consumers from emerging risks. In a blog posted by CGAP the authors stressed the need for greater emphasis on consumer protection. The same blog points out that issues with transparency, for both demand and supply side data and issues with responsible lending contribute to high delinquency and default rates in digital lending. About 50% of digital borrowers in Kenya and 56% in Tanzania reported that they had paid late.

It is still not the case for Ethiopian customers, where regulators can learn from the Kenyan experience in enacting consumer protection policies related to digital credit products while fostering a collaborative environment among service providers. Collaboration among service providers and credit bureaus is key to finding solutions to the over-indebtedness of businesses and individuals.

While consumer privacy is crucial, there needs to be a methodology for service providers to share information with the purpose of protecting multiple service providers from disbursing loans to a single individual to minimize risks and avoid duplicate loan disbursements. This will help financial service providers avoid over-indebting their clients, reduce late repayments and default rates. The same CGAP blog cited above found that about 12 percent and 31 percent of borrowers in Kenya and Tanzania, respectively, said they have defaulted on their loans. This has led service providers to disregard defaulters’ personal privacy by shaming them publicly, e.g., (by calling friends and family), registering them as defaulters in the credit bureau for small amounts of money, and other tactics to get their money back. Because of this, customers are compelled to take more loans to repay previous loans. This situation can be avoided in Ethiopia as the service is new to the market.

Solving the working capital needs of retailers like ‘Emu’ remains the centerpiece of the puzzle in making finance accessible to all. To support digital credit borrowers, regulators can strengthen the consumer protection directive issued in 2020. Ethiopia’s credit bureau at the National Bank of Ethiopia (NBE) is also increasing its engagement with service providers, after its mandate was amended in a directive issued in 2019. However, there is a critical need for a targeted approach to strengthen the consumer protection initiative for digital credit products.

Partnerships and launches of digital credit products are commendable and there is a large market to serve. The current loan rates for digital credit products range from 1 percent to over 20 percent, which is recognized as interest or as a facilitation fee or a combination of both. The repayment period varies depending on the service provider and the type of digital loan offered. Some loan product operations are not purely digital but a combination of manual activities and digital solutions, which should be assessed before scaling up. The current available digital loan product repayment period ranges from one day to one year. For some digital products, the interest rate is not publicly disclosed unless borrowers access the digital applications or the service providers’ branches.

Back to shopkeeper Emu and her peers, who can benefit more from transparent service delivery, which includes financial education and the regulator’s consumer protection law. Financial service providers (including digital lenders) need to invest in awareness and transparency about the terms and conditions of their digital lending products, for example through financial literacy. A better understanding of terms and conditions will benefit service providers as usage increases and a collaborative environment that leads to lower rates of late payment and default.

The question remains: how can we effectively scale access to finance for individuals like Emu through cost-effective digital channels while safeguarding them from malpractices such as information omission, high interest rates, duplicate loans, limited financial literacy, and incomplete product information? The UN Capital Development Fund (UNCDF) program, Digital Financial Services For Resilience (DFS4Res) is actively collaborating with the country’s government and private sector stakeholders to deliver solutions that address these challenges.

The primary objective of the DFS4Res program is to enhance consumers’ capabilities to utilize digital financial services through various means. This includes improving consumer awareness, facilitating responsible financial practices among institutions, fostering collaboration among service providers, and introducing accountable and innovative digital products. Furthermore, the program aims to expand digital and financial literacy access, empowering individuals like Emu to make informed financial decisions.

1. Emu is one of the retail shop owners interviewed in person on her regular business and agent banking service she is providing to her customers.
2. https://pedl.cepr.org/publications/assessing-impact-covid-19-small-scale-manufacturing-establishments-ethiopia#:~:text=Overall%2C%20our%20results%20underscore%20the,the%20same%20period%20last%20year
3. https://ethiopianmonitor.com/2023/06/28/cbe-tele-partner-to-start-digital-micro-financial-services/
4. https://dashenbanksc.com/dube-ale/
5. https://www.centralbank.go.ke/uploads/press_releases/566112348_Press%20Release%20-%20Suspension%20of%20The%20Listing%20of%20Negative%20Credit%20Information%20for%20Borrowers.pdf 
6. https://www.centralbank.go.ke/wp-content/uploads/2022/06/Procedures-for-licensing-Digital-Credit-Providers-Revised.pdf
7. https://punchng.com/google-deletes-loan-apps-in-kenya/#:~:text=Google%20has%20taken%20down%20hundreds,licence%2C%20took%20effect%20in%20January.