By Beth Rhyne
Why should digital lenders support consumer protection principles and practices? What’s in it for them? After a decade of experience with digital lending, it’s high time to answer this question.
The operations that need attention include both “nanolending” burgeoning in East Africa and larger personal and small business lending in multiple regions. There are clearly predatory practices already taking hold. Moreover, some lenders incorporate business model elements which they may consider necessary, but which consumer advocates view as unacceptable, such as failure to consider ability to repay, data privacy problems, and lack of complaints channels. Unfortunately, because many digital lenders operate beyond the regulatory purview, we know too little about how prevalent consumer harms are. However, a recent example was documented by The Financial Times: credit shaming in Kenya by debt collectors employed by digital lenders (September 10, 2020). Some of the lenders in question, such as Branch and Tala were started by well-known Silicon Valley entrepreneurs.
When microfinance was at a roughly similar stage of development as digital credit is now, and most providers were still largely unregulated and legitimate concerns about consumer protection were being raised. In that context, the Smart Campaign, with support from leading sector participants, developed standards and a certification program to recognize institutions for good consumer protection practices. Over the next decade, over 120 institutions serving 50 million customers met the detailed standards and became certified. Two major factors attracted microfinance institutions to certification. One was the shared commitment among providers and investors throughout the sector, to microfinance as a socially-beneficial and pro-consumer endeavor, leading to a desire to showcase their own performance in this regard. The other was the drive for institutional legitimacy as leading microfinance organizations sought to become regulated financial institutions.
Recently, the supporters of the Smart Campaign concluded that because these same motivations were missing in the much more unruly digital lending space, the recognition conferred by certification would not attract digital lenders. Accordingly, they closed the campaign and the certification program.
While it is clear that social motivation and desire to be regulated are not as salient among digital lenders as they were among microfinance institutions, neither are they completely missing. Examining the motivations of digital lenders reveals opportunities to advance good consumer practices, even if these opportunities are less dramatic than certification. In this post, I consider how concern with social image may be a motivator in the absence of regulation, and in a subsequent post I’ll talk about the role of regulation.
To begin, there is a segment of digital lenders who entered this space with social motivations. This segment can be strengthened and its voice made more salient. A number of the entrepreneurs and investors behind digital lending are this generation’s version of the idealists who founded microfinance institutions. These folks are not dominant in the sector, and they do not set the overall tone, which is plainly commercial. Nevertheless, the socially motivated segment of digital lenders and investors, if united and assertive, would have enough weight to influence the tenor of the sector toward good consumer protection practices.
At the same time, it would be a mistake to assume that the dominant and purely commercial players are impervious to social norms. Most business leaders want to be seen as good corporate citizens. They know that poor reputations damage relationships with customers and investors. A pro-consumer reputation even helps in staff recruitment and morale. Accordingly, carrots associated with positive recognition and sticks associated with bad press can nudge digital lenders toward good practices, provided they do not result in competitive disadvantage (which is why regulation is also important, but more on that in the next post).
One carrot is to make good practices easy to adopt by developing and sharing pro-consumer practices proven to work in digital business models. To explore how such sharing could work, in 2017 the Smart Campaign convened Fintech Protects, a group of fintechs who met regularly to discuss innovations in consumer protection privately with each other. It is important to note that the group included a mix of socially and commercially oriented actors. The members were prepared and even eager to talk shop with each other – in a safe space. Three conditions were necessary to create a safe space: 1) exclusion of investors and regulators from the conversation, 2) anonymity in any publication of findings from the work and, 3) sharing across countries so that few participants were direct competitors.
According to Alex Rizzi, the coordinator of the group, the members of Fintech Protects brought their tech start-up culture into the conversations. For example, a digitally delivered product needs a robust customer service function, and lenders were keen to know how best to set up such a function. The group had a lively discussion around the pros and cons of call centers, chat bots, live chat, and the like. They were eager to share problem solving techniques.
Some facets of consumer protection were more suitable than others to the Fintech Protects approach. The group was most comfortable working on topics related to customer treatment, where good practices benefit lenders by ensuring that borrowers are happy with the service they receive. These were also areas of the business that the digital lenders were unlikely to view as part of their core intellectual property. Productive topics included complaints handling, transparency, and data privacy. Aspects of the core business model – such as interest rates, fair algorithms, and portfolio quality – were much harder to discuss, even in a safe space. Underwriting methods were especially likely to be seen as closely guarded trade secrets.
Most members of the group reacted against conforming to specific standards, preferring to look for innovative solutions that might look different from one lender to the next. Nevertheless, a few members asked to enter the certification process and cooperated with the Smart Campaign to test provisional digital lending standards. A conclusion from this experience is that while a standards-based certification process may not be the best approach, digital lenders are eager for some forms of recognition, such as the prizes and awards that feature prominently in the fintech sector. Overall, the Fintech Protects experience demonstrated interest by digital lenders in responsible practices, to enhance both their customer relationships and their reputations. However, the culture clash remains between the tech sector’s ethos of independence and disruption and the more formal approach that sets norms for consumer protection. .
Tackling consumer protection practices that are deeply embedded in business models is probably beyond the reach of voluntary mechanisms, particularly because such issues as pricing and underwriting can directly affect profitability. Significant changes in these areas will require regulation, or at least the threat of regulation. In my next post, I will contrast the ways the prospect of regulation affects the consumer protection orientation of microfinance institutions and digital lenders.
There is a long way to go to embed consumer protection in digital lending, and it’s time for the work to accelerate. While it won’t be easy, let’s not assume that digital lenders are as uninterested in getting it right for their borrowers, and let’s craft solutions that build on the innovative and agile personality of the sector.