Can digital credit work for development?

There are two times of day when M-Shwari, a digital banking platform in Kenya, sees huge demand. The first is in the early hours of the morning, when women prepare their produce for sale at the market. The second is late at night, when men place their bets on sports.

The rise of digital banking means that people around the world can now borrow, save or pay with their mobile phones. Digital credit providers are using alternative sources of data to determine creditworthiness and provide loans to populations that have never had access to them before.

But while these products offer a convenient way for consumers to access cash for personal or business expenses, they also present risks. If borrowers do not understand the loan terms, or take out more than they are able to repay, the result can be overindebtedness or a negative credit report.

“Is [digital credit] a development boon or drag?” asked Kate McKee, who works on responsible digital finance at CGAP, a global partnership housed at the World Bank. “[Is it] welfare enhancing or temptation enabling?”

The truth is somewhere in between, she said during a presentation at a matchmaking workshop in San Francisco last week, where a range of stakeholders discussed how digital credit can help rather than hurt those who have access to it.

Opportunities — and risks

Digital credit differs from traditional bank or microcredit loans in four key ways, said Jonathan Robinson, one of two scientific directors at the Digital Credit Observatory, an applied research network funded by the Bill & Melinda Gates Foundation and facilitated by the Center for Effective Global Action at the University of California, Berkeley.

First, he said, transaction costs are lower; second, loan approval and disbursement can be instantaneous; finally, it benefits from improved credit scoring, and better product customization. Digital credit is not just microcredit on a cell phone, he said, explaining that it is a totally new technology.

There is a knowledge gap around how digital credit products alleviate or entrench poverty, however. Robinson said that its popularity and potential consumer base makes it worth looking at, and that there is a time-limited opportunity to research this rapidly developing field, with little or no existing rigorous, large-scale, quantitative evidence.

The Gates Foundation is supporting CEGA to develop such an evidence base, exploring the impact of digital credit products as well as the effectiveness of consumer protection mechanisms in emerging markets. The Digital Credit Observatory is part of a growing effort to determine what consumer protection measures need to be adopted in policy and regulation as well as industry for the digital finance field.

The GSMA, which represents mobile network operators worldwide, has developed a code of conduct for mobile money providers; the Better than Cash Alliance has released responsible digital payments guidelines; and the World Bank will publish an updated version of its “Good Practices for Financial Consumer Protection” later this year. The Digital Credit Observatory aims to accelerate these efforts with an emphasis on ensuring that borrowers are protected against risk.

Developing an evidence base

The matchmaking workshop last week aligned with a strategic priority of the Digital Credit Observatory: Building a strong network of research, private sector and policy partners in the digital credit arena. Academics, mobile network operators, lenders and representatives of organizations including the World Bank and the Gates Foundation came together to discuss the current landscape of research on digital credit as well as open research questions.

“To what extent has digital credit and reporting expanded financial access, choice and control for financially underserved customers?” asked Yoni Blumberg, product manager at Tala, a Los Angeles-based startup that uses an app to provide financial identities and short-term credit to underserved consumers. “You are our best allies in getting to that answer.”

In February, CEGA put out a request for proposals, seeking applications for $20,000 pilot grants for early stage research projects answering the following three questions:

1. What are the short and long-run impacts (both positive and negative) of digital credit on consumers in emerging markets?

2. How can digital credit products best reach consumers who are left out of the formal credit market?

3. How can digital credit algorithms, regulations and other consumer protection measures such as improved loan and consent terms, reminders and other behaviorally informed messages, be designed to minimize default, over-indebtedness, leakage, fraud and other risks to consumers (and providers)?

Based on these proposals, the Digital Credit Observatory made five pilot grants, for early stage, exploratory research on topics including “gender-differentiated credit algorithms using machine learning.” The grants went to CEGA affiliates — faculty mostly based across the state of California, who are building on some of their past research on financial technology for global development. The matchmaking workshop highlighted several additional questions the team at the Digital Credit Observatory would like to see the research community answer, with their financial support.

Ensuring consumer protection

Because of a relatively loose regulatory environment, the onus is on the lender to figure out how they want to write the algorithms that power digital credit scoring, said Joshua Blumenstock, also a scientific director at the Digital Credit Observatory. Depending on the approach, fair lending algorithms can serve as a consumer protection measure — but only when the lender sees it in their interest to minimize the risk to borrowers, to prevent fraud and manipulation, and balance privacy and accuracy. His presentation pointed to an opportunity for the global development community to work with others to gather evidence on the problem, test potential solutions and create incentives to scale them.

Another presentation at the event by Sitoyo Lopokoiyit, director of m-commerce at Vodacom Tanzania, looked at M-Pawa, a digital money product that offers both credit and savings features. Lopokoiyit’s example of using interactive SMS to teach M-Pawa customers how to borrow and save responsibly points to the importance of financial education alongside financial inclusion to expand the focus from credit to savings.

“The first key takeaway for me is the role of algorithms,” said William Nanjero, a principal consultant at MicroSave, an international financial inclusion consulting firm, who traveled from Nairobi to San Francisco for the event. “Delinquency is one of the biggest issues in credit. If you can reduce the delinquency rate, then you’re able to serve the customers better.”

But Nanjero echoed the concerns of others in the room that some operators and lenders may not prioritize consumer protection as much as others.

“Digital finance has had a lot of donor interest, but digital credit is something that has still been underdeveloped, so having donors zooming into this subset and actually having a lot of interest around this is very important,” he told Devex.

While McKee of CGAP has worked on consumer protection for more than a decade, she said she had never heard the term come up so many times in the span of three hours as she did at the event last week.

“In what ways can we optimize the potential benefits and mitigate some of the downside risks?” she said in an interview with Devex. “A lot of it has to do with behavioral biases that we know consumers have around credit, and how they present differently in a digital environment.”

CGAP has partnered with the Busara Center for Behavioral Economics in Kenya, and Jumo, a mobile money marketplace, to design experiments in Kenya to measure consumer response to different communications. Together, they developed a series of tests to see if changing the messages consumers receive when they sign up for and borrow using a mobile money product could change consumer behavior. Based on these experiments, they designed adjustments to menu screens to improve consumer understanding of costs, inform their decisionmaking when borrowing, and send reminder messages to increase repayment.

“There may be very responsible commercial players who would prefer to have a business model that’s more transparent, has more fair treatment built in, deals with customer complaints in a more effective way, but it’s hard for them to make those investments if their competitors don’t have to meet some basic standards,” McKee said.

“That’s where there’s kind of an interplay between good practices that some providers are doing and trying to get those codified into industry standards and regulation.”

Update, June 1, 2017: This article has been updated to clarify comments from Kate McKee.

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