The Credit Dilenma.
Zuckerberg might not be your hero of ethics, but do you think he imagined how Facebook would be a force good and evil in almost equal measure? Did Kevin Systrom know that a product for sharing digital post cards would ever make people depressed and suicidal. Did the Snapchat founding team know that there’ll be a mental health challenge called Snapchat Dysphormia?
We build mostly for the good the product can bring and how impactful the ripple effects of it would be. How powerful. How beautiful. How it would make the world a little bit better. Not often do we think about the bad and how the impact can be a disastrous epidemic.
I continue to be an advocate for creating more credit sources for individuals, but mostly businesses because I believe it can be a great thing and the impact can be phenomemenal. Increased purchasing power, increased productivity, better cash flow, increased income, reduced unemployment rate and many other amazing things. I’m always very happy to see credit companies rising. In 2017, it is recorded by the Financial Inclusion Secretariat that a meagre less than 5.3% of the adult population had been beneficiaries of credit from the formal sector. More recent data by EFinA in 2019 say that the ratio is even less than 3%. Nigeria’s premier bank is targetting a 40% ratio. It is important that this becomes a reality and maybe even at a higher ratio; and not informally, but formally. Receiving credit formally is very important as it gives room to receiving even more credit formally.
However, the good impact of credit is heavily dependent on the beneficiaries acting right with it. Some of the things neo-credit products are trying to do is lower the bar for access to credit, improve convenience and ease the process — Very important factors that would boost financial inclusion in terms of credit. The challenge is that borrowers are usually unable to properly judge their ability to pay, the sort of pay structure that is a better fit for them, the kind of activities or purchases that they should get a loan for, the details of their interest responsibility, not falling into a debt vicious cycle and bankruptcy. Money is tempting and for most people, whatever means they can purchase more, acquire more and spend more is good news. It is good new indeed, but what was created to pull people into riches can easily plunge them into poverty and I believe that this should be a concern for all lenders.
A lot of lending is still based heavily on income size, without factoring earning structure and spending pattern or responsibility; and still not putting sufficient weight on payment history. Lenders can offer up to 6 times a borrower’s monthly income without factoring that the borrower spends up to 70% within the first week of receiving a payment. Offering 50% of a person’s monthly income as a short term loan offer can be a heavy strain on said person if their responsibilities outweigh 50% of their income. People with irregular earning streaks, can be dissorientated when payment dates near if they haven’t earned yet or enough or if they can’t figure out their next pay date. Borrower’s are hardly ever able to think about these factors. If they glimpse that payment is feasible they would cup a loan, only too be shy on payment dates. Deciding how much exactly they are comfortable with and the payment structure more suitable for them is just a decision that borrowers still don’t make out time to make and sometimes, they aren’t even faced with. Falling into a vicious debt cycle becomes hard for borrowers like this and while the lender might enjoy the relationship, even a good debtor has bankruptcy lurking somewhere eventually.
Some borrowers have a very difficult time understanding what purchase is credit worthy or not. Some purchases can be delayed and some are too risky for loans. Take for instance, lenders who borrow money to go in on a bull run for a stock or cryptocurrency only to be met with a sharp loss. There are borrowers who can be very confident about their gambling abilities, that they feel very comfortable borrowing money to bet or play the lotto — as visibly evidenced in the Kenyan’ credit market. This is problematic for two key reasons. Lenders are in the business of making money from giving loans. When NPL ratio keeps rising this can become a disastrous problem as the lender can become bankrupt; It is important to understand that bad debts are expensive to recover, even though not impossible. The other harmful effect of this pattern is that when naive borrowers are reported to credit bureaus, they fall of the pool of people that can be loaned to. These set of borrowers become financially excluded as opposed to the initial aim of including them. That this borrower didn’t pay back a loan like this, doesn’t mean that they wouldn’t have been able to pay the loan; the activity which the loan was used for turned out unproductive. Providing them loans for more productive activities can help them wipe out the bad loan, however, once they are reported, it becomes difficult for them to get another loan and even if they do, it could most likely be at a significantly higher rate.
Interest rates for quick loans can be as high as 360% per annum; this doesn’t factor in compounding interest on defaults and that is lost on many borrowers and when the amounts are tiny it is even more lost on borrowers. A 2,500 naira interest on a 10,000 naira loan after one month is ‘convenient’ for many digital borrowers but it is lost on them that this is a whopping 300% per annum. Digital loans are typically very expensive because the data points received are not as much, making it heavy risk and lenders are thinking about covering up for losses that will inevatibly occur. This however, isn’t beneficial to the recipients who are paying really high fees for these loans. Ordinarily, the assumption would be that as the lender makes swift payments, their loan terms will become fairer; it hardly does and not significantly when it does.
Something about quick, easy, digital loans is that it makes many beneficiaries assume that they are invinsible and always, there are those with the intention to borrow but never to pay. “I just want to borrow like 6,000 naira from Branch and delete the app from my phone”. I’ve heard this and it’s variations from students especially. Imagine starting life with a bad credit score; but many of these students are completely unaware of the effects of being a bad debtor and how a bad credit score isn’t anything appealing in any way. This line of thought isn’t unique to students. There are those who are interested in taking loans from multiple platforms to starts businesses that they wouldn’t be able to sustain.
In extreme cases, a case of inability to pay debt(s) can lead some to; become depressed, bankruptcy, suicidal thoughts, partake in illegal activities, anxiety disorder or a difficult vicious debt cycle. It is almost a duty to protect users from themselves if a robust, impactful credit economy would be developed.
It is almost like there is a responsibility to save borrowers from themselves before it becomes a catastrophy; keeping in mind that this catastrophy is a two jagged edged sword that would hurt both borrowers and lenders, with the jagged edges focusing on distorting the macro-economy of the host community.
What Can Credit Providers Do?
Structure Loans Better: Putting into consideration factors like spending habits, responsibility cost and income to debt ratio into credit decisions can be an effective way to provide more payment convenience and help people develop richer credit habits.
Deny Loans: As much as neo-credit providers want to be more credit access inclusive, it would be wise to borrow a leaf from older traditional lenders and create a standard of who cannot get loans based on solid verified financial information, not flimsy unchecked ones like the type of phones they use or the area they live. Denying loans to a person who seems to be developing a growing appetite for credit is a good step in quelming the looming debt cycle they are unaware they are dragging themselves into.
Educate Borrowers : Educating borrowers on the essence of good credit behavior, best credit practices and effect of bad credit behavior can go a long way to discourage bad credit habits from a position of naivety and misinformation.
Reward Requital: Rewarding payback visibly is a good way to encourage more people to do it. It is not enough to punish the bad, but rewarding and emphasizing the good can bring about the desired credit behaviour.
Focus On Debt Recovery Strategy: Covering up for lost debt with paid debt as the major strategy for mitigating against loss for a lender would definitly leave interest rates high; this becomes a punishment for those who payback as they are now responsible for those who pay and those who don’t.
Collect and Verify Data: Collating sufficient data, verifying that the data given is genuine and basing decisions on true data can improve credit structure decisions as well as eligibility.
Finding Balance: Finding a balance between speed, ease and convenience and issuing non-predatory loans to those who need and can afford it should be a core goal for credit providers. Sacrificing good credit rating and structure decisions on the hill of “quick loans for everyone” can be a great short term play but is likely dentrimental long term.
There is definitely a lot more that can be done with nuance and specialization that can be done with credit issuance. My hope is that we think about protecting borrowers from the detrimental side of loans as much as we are exposing them to access it; to boost their productivity, purchasing power and wealth building.
