Digital credit is no longer a question of if, but when
Despite impressive progress in financial inclusion over the last few years, about 40% of the adult Bangladeshi population are still outside the purview of financial institution (FI) products and services.
In the context of Bangladesh, banks and microfinance institutions (MFIs) comprise FI’s. Therefore, a whopping 64 million people have little to no access to basic financial products and services. They cannot keep money in a savings account or avail of a personal loan, let alone a business loan.
While efforts to promote financial inclusion have focused on providing access to opening FI accounts and promoting savings products among the bottom-of-the-pyramid (BoP), Covid-19 has driven home the importance of accessing credit for the unbanked population.
Meanwhile, access to credit for cottage, micro, small, and medium enterprises (CMSME) continues to be a high priority in the government’s Covid-19 response since these enterprises have been the hardest hit by the economic shutdown.
A large number of CMSMEs operate in the informal sector, representing a lion’s share of the country’s 7.81 million enterprises. Concerns remain whether the vast number of informal enterprises will have access to the Covid-19 recovery loans distributed by banks, since they do not often have bank accounts.
Globally, digital credit has received growing attention amid Covid-19, due to its potential for quick and efficient appraisal, approval, disbursement, and repayment. In Bangladesh, owing to increasing movements of bKash and Nagad into the digital credit space, not to mention, successes of ShopUp, digital credit is no longer an alien concept.
Demand for digital credit
Historically, providing credit products to cottage, micro, and small enterprises has been difficult for financial institutions due to both the risks and operational costs involved. The Bangladesh Bank has long rallied banks to increase their share of loans to this segment.
However, the recent interest rate caps, a 9% loan interest rate cap, and a 6% deposit rate cap have squeezed loans to small businesses. Banks incur substantially higher costs when they loan to smaller enterprises per loan, given the smaller size of these loans. However, the rate cap has also highlighted the business case for digital credit for smaller retail loans. According to several banking industry leaders, digital credit is no longer a question of if, but when.
Then there are more specific use cases of digital credit, such as its use in supply chain financing. Small suppliers often cannot join the supply chain ecosystem of large conglomerates due to the payment terms set by the latter.
Such payment terms directly affect supplier’s cash flow and hence hurt the business overall. Digital credit can expedite supply chain financing for the suppliers and thus unlock access to the supply chain ecosystem of large conglomerates, thereby greatly accelerating growth of many small enterprises.
The rise of startups has also brought forth avenues for digital credit. With the growth of digital platform-based businesses such as Pathao, Sheba.xyz, etc, a new generation of micro-entrepreneurs have joined the so-called gig economy as service providers.
The scale of this gig economy is ever-expanding. Pathao currently has over 300,000 riders. Sheba.xyz has 50,000 businesses it supports and ShopUp services around 500,000 MSMEs. Pathao’s riders, and Sheba and ShopUp’s microbusinesses, are part of the larger ecosystem of small businesses that could greatly benefit from digital credit.
These micro-entrepreneurs and small businesses are usually underserved and overlooked by formal financial systems, for lack of necessary documentation required for bank loans. Moreover, their businesses are usually too novel to be easily financeable for banks.
However, the data generated by the said platforms, eg, Pathao, Sheba, and ShopUp, have tremendous value for alternative credit scoring, and thereby, loan underwriting by financial services providers.
Avenues for digital credit in the microfinance sector have received much attention recently. Accounts from the experts working in this sector reveal that nearly one third of the total loan portfolio (on average Tk50,000 crore out of Tk1.5 lac crore) of the microfinance sector are disbursed each year among cottage, micro, and small enterprises in the form of microenterprise loans.
However, MFIs are often criticized for the high interest rates. Digital credit in the microfinance sector could transform loan operations from their human-intensive state to a technology-intensive state.
This is likely to have an impact on interest rates charged as well. The challenge for MFIs is the lack of a digital footprint of the small business clients they service. However, given the increasing penetration of smartphones among the rural population, a digital footprint is not something that will remain elusive for too long for the majority of the population.
Challenges for digital credit
The road to mass deployment of digital credit operations requires building an infrastructure that would facilitate the customer onboarding process digitally. The first step to this is e-KYC for the purpose of loans, which is not yet fully deployed, although there are reports that bKash and Citybank are developing this capability, among others.
Legal barriers and absence of appropriate laws for dispute-handling related to digital signature, digital consent, and digital documents impede digital onboarding. Cumbersome paper-based loan application processes often discourage cottage, small, and micro entrepreneurs.
Experts suggest reducing the number of pages of paper-based loan applications, from a fourteen-page to a two-page application form, significantly increases the likelihood of loan applications among marginal entrepreneurs. Digital onboarding, with the use of e-KYC and other technologies, could simplify the loan application process further and facilitate subsequent stages of loan operations.
Lack of digital infrastructure for appraisal and approval of loan applications constitutes a major bottleneck for digital credit deployment. Financial institutions often do not have real-time online access to documents necessary for credit appraisal and decision-making. Verification of bank statements, trade license, land and properties, etc, still requires several in-person visits.
Moreover, while banks and non-banking financial institutions can verify National Identity Cards (NID) electronically, MFIs cannot. Considering the huge segment MFIs serve, a market of 40 million customers, this is a major setback.
Digital transformation of MFIs is also equally important to create a digital data footprint of the customers, which can open up new avenues for offering other financial services for the bottom of the pyramid population.
Building a digital infrastructure that would enable the financial institutions to verify all types of documents in real-time is a prerequisite for the diffusion of digital credit. Extending the scope of NID cards can facilitate such digital transformation by connecting the data silos residing in servers across governmental institutions, financial and non-financial institutions, and regulators. The Indian example of Aadhaar card and account aggregator could be a useful case study in this regard.
Mass acceptance of MFS across the country over the last few years has created significant space for the disbursement and repayment of loans. Leveraging MFS has facilitated speedy disbursement and repayment of loans for financial institutions.
However, further transformation of MFS as a regular channel for digital credit operations is required. Existing limits on transaction value and costs associated with transactions are bottlenecks for the repayment of loans through MFS.
Allowing to receive and repay the loans at reduced costs, irrespective of ticket size, could facilitate digital credit operations greatly among the cottage, micro, and small enterprises. Moreover, transaction data of more than 800 million MFS wallets can be used as an important component for alternative credit scoring.
Nano credit needs a cautious approach
Following its rapid diffusion in several African countries, nano credit has received widespread attention among developing nations as a tool for providing instant access to credit. Nano credit providers use smartphone data, ranging from airtime usage and social media behaviour, to assess the credit worthiness in real-time.
Once a credit decision is made using sophisticated algorithms, the disbursement can happen near-instantly through the mobile wallets. These nano credits have a small ticket size of typically $30–50, high interest rates, and have four weeks on average as the repayment period.
Nano credit has recently come under intense criticism due to its socio-economic consequences in Kenya and Tanzania. In a survey conducted by Consulting Group to Assist the Poor (CGAP), 31% of Tanzanian borrowers and 12% of the Kenyan borrowers have defaulted.
The survey has also found that a significant number of borrowers have taken multiple loans from more than one provider. Debt cycling is common among borrowers since they often attempt to repay one loan by taking another one.
Nano credit has also resulted in financial exclusion. Media accounts suggest that the majority of the 3.2 million Kenyans blacklisted in 2020 by credit reference bureaus (CRBs) for defaulting were nano credit borrowers. Many of the blacklisted borrowers often owe less than $9 and are barred from future loans. The instant access to credit has also resulted in increased sports betting among young male Kenyans.
Regulators have started to step in to curb negative consequences of nano credit in these countries. Allowing nano credit in Bangladesh would require regulatory interventions so that the predatory behaviour of the providers and negative social consequences are addressed and controlled.
Digital credit has great potential in the CMSME space. CMSMEs account for 25% of the country’s GDP and employ 87% of the workforce. As described earlier, digital credit is relevant for both traditional enterprises and the new generation entrepreneurs of online platforms.
However, significant transformation and digitization across financial institutions, government agencies, and regulators are required for large-scale diffusion and adoption of digital credit. Representatives of government agencies and regulators suggest that many praiseworthy initiatives are being implemented towards building a digital infrastructure in the country.
A national portal for the purpose of real-time trade license verification at the city corporation level is underway; a central database of land and property registration documents is being built; and a CIB database for the MFIs is currently in process.
These developments would greatly facilitate digital credit for the CMSME sector. Nano credit has resulted in negative economic and social consequences in Kenya and Tanzania, but there are good examples, as well. Nano credit can be a great instrument for greater financial inclusion and easy access to credit if the borrowers use the loans in productive ways and regulators play their part.
Digital credit is a novel concept across the world, not just for Bangladesh. Regulatory sandboxes in which all relevant stakeholders, including the financial institutions, telecommunications companies, MFS, regulators, and government agencies, are participating, can present responsible digital credit products to both individual customers and CMSMEs of the country.
Oliur Rahman Tarek is Research Associate, CES, ULAB.