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Innovation in the financial technology (fintech) industry has been growing steadily over the last few years, mainly driven by digital payments. According to a study commissioned by Financial Sector Deepening Uganda in 2018, digital payments represented 47% of fintech activity in Uganda. The Bank of Uganda (BOU) Financial Stability Report, 2022 also indicated a high volume of activity in digital payments, with the value of mobile money transactions growing by 46.5% to UGX 145.6 trillion and the value of internet and mobile banking transfers growing by 82.8% and 146.1% respectively.
Growth in fintech activity has however not been limited to digital payments. There is increasing innovation in digital lending, and digital technologies are being deployed in the process of extending credit to customers – and in doing credit assessments, disbursements, repayments, and other credit related processes. This growth is evident with entities such as MTN Mobile Money that reportedly disbursed over UGX. 340 billion through its mobile lending products in 2022.
Innovation in digital lending is critical because it addresses the access to credit challenges for a population that has traditionally remained on the fringes of formal credit systems – and largely relies on family, friends and SACCOs as sources of credit. Some authors like Jimmy Ebong and James Babu have argued that access to credit enhances financial inclusion and digital lending is a channel for banking the poor.
A couple of digital credit providers are regulated by BOU pursuant to the National Payment Systems Act. However, in the recent past, new digital lenders that have entered the market space and it is not clear whether these new digital lenders are under the regulatory purview of BOU. Their continued operation with uncertain regulatory oversight has resulted in several challenges that remain unchecked. This article highlights the challenges arising from a lack of regulation and makes the case for a comprehensive regulatory framework governing digital lending to streamline growth in the industry.
Structure of operations of the new digital lenders
The digital lenders typically run their operations via mobile applications (“app”). The process of signing up for the service requires the customer to mandatorily grant the lender access to the customer’s entire phone book, messages, gallery, location data, national identification data, financial information, and the photo of the customer. The customer is also required to provide contacts of persons who in the event of default are contacted, as part of the recovery measures.
The customer then applies for a loan and the application assesses the credit available to the customer. The loan tenor is typically 7 – 14 days, and the interest rate is usually 30%. The loan is disbursed directly to the customer’s mobile money, less a service charge of about 25%. Therefore, if a customer applies for a loan of UGX 100,000, they will receive UGX 75,000 and repay UGX 130,000 at maturity date.
The lender recovers from the borrower either via USSD or through the app and the day before the maturity date, the lender’s collection agents start contacting the borrower to repay their loan. The number of calls increases on the maturity date and intensify in the event the borrower does not meet their obligations on the maturity date. The lender also applies a 2.5% daily penalty charge for each day of default.
Challenges arising from the operations of lenders
The key challenges that borrowers continue to face with unregulated digital lenders include:
- Data privacy breaches primarily arising from unauthorized sharing and processing of customer data;
- Predatory lending practices, characterized by unclear loan terms and exorbitant interest rates and absence of customer redress mechanisms;
- Debt shaming, which usually occurs at the time of recovery. The recovery agents contact people known to the borrower and ask them to urge the borrower to settle their loans; and
- Other unethical practices that include threats, bullying, blackmail, and extortion of borrowers – as recovery practices.
It is imperative to note that the challenges posed by the operations of unregulated digital lenders are not unique to Uganda. Similar trends have been reported in other markets such as in like India and Kenya. The Central Bank of Kenya, in response to these concerns enacted regulations governing digital credit providers to address the challenges highlighted above. Other regulators such as the Office of the Data Protection Commissioner of Kenya have also acted sternly and slapped these lenders with fines for data privacy breaches, the most recent being Whitepath, which was fined Kes. 5 million for mining customer contacts and sending customers unsolicited messages.
The case for regulation
For digital lending to grow, it is pertinent to ensure an orderly sector that inspires customer confidence and offers reliable alternatives to the formal credit channels, marked by transparency, consumer protection guardrails and a prohibition on unethical recovery practises.
The foregoing is attainable through a comprehensive regulatory framework governing digital lending. For example, the Central Bank of Kenya (Digital Providers Credit Providers) Regulations, 2022 (“CBK Regulations”) provide for the following critical aspects:
- Licensing criteria for the digital lenders – including the requirement for at least one physical office;
- Business conduct standards that require the lenders to seek approval of credit products prior to launching them on the market, providing customers with the terms and conditions of the products and parameters on interest recoverable on loans among others;
- Consumer protection standards such as customer complaints mechanisms;
- Prohibitions on unethical debt recovery practises such as unsolicited calls and threats; and
- A limitation on the amount of information collected from customers.
The Reserve Bank of India has also adopted a similar approach and enacted a comprehensive framework that, among others, imposes an obligation on digital lenders the obligation to be responsible for data protection and privacy and complete disclosure of all the costs applicable to the loans.
While it may be argued that the regulation of digital lenders in Uganda would fall under the ambit of the Tier 4 Microfinance Institutions and Money Lenders Act, which regulates the activities of money lenders, the law remains insufficient to address the nuances that digital lending involves. For example, S.85(1) of the Act requires a money lending contract to be in writing, signed by both the lender and borrower and witnessed by a third party – which aspects may not be directly applicable to digital lending.
The Act however provides for powers of the Minister, in consultation with the Uganda Microfinance Regulatory Authority, to prescribe maximum interest rates that money lenders may charge. The CBK Regulations fall short on this aspect and leave the question of interest rates as a matter subject to the contract between the borrower and the lender. It may however be critical to also regulate interest rates in digital lending transactions to protect borrowers from predatory lending practises.
Conclusion
Borrowing and lending agreements must be arranged in a transparent business environment that fosters fairness and due regard to customer interests. Regulation of digital lenders will go a long way in addressing the negative downsides to the lack of regulation and ensure an orderly sector. Uganda may benefit from benchmarking on the practices adopted in India and Kenya in the development of local regulations.
Disclaimer: “The views and opinions expressed on the site are personal and do not represent the official position of Stanbic Uganda.