Evans School Policy Analysis & Research Group (EPAR)

Digital credit refers to loans that are issued remotely (often without any brick-and-mortar infrastructure), automatically (minimizing the time and number of steps between registration and the distribution of loans), and instantly (often in less than 72 hours), as defined by the Consultative Group to Assist the Poor (CGAP). Like other digital financial services (DFS) such as mobile money, digital credit exists in an overlapping regulatory environment. For instance, digital credit products that use a mobile money platform to approve and disburse loans may fall under the regulatory authority of a financial regulator, a telecommunications regulator, and a competition authority all within one country.

Many countries have high-level regulations or guidelines focusing on consumer protection, competition, mobile money or electronic transactions, agent or branchless banking, customer service or dispute resolution, or payment systems and banking. In many cases, these regulations will apply to digital credit providers. Even still, existing regulations may not cover all digital credit products, such as products that exclusively use online platforms instead of mobile money channels. Reports from the Center for Financial Inclusion and the University of Hong Kong Faculty of Law note that it can be unclear if digital credit providers must also comply with regulations for formal banks and other financial institutions, and the relevance of existing regulations to digital credit in a given country may require years of litigation to establish. 

The emergence of new digital credit products has created some regulatory concerns, mostly around consumer protection and limiting risks to financial markets. In EPAR Technical Report #351b, we searched for and reviewed examples of new or planned regulatory documents targeting digital credit in Asia and Africa, to understand whether governments are addressing concerns associated with digital credit that may not be covered in broader existing finance, telecommunications, and competition regulations. We did not find any regulatory documents using the term “digital credit” specifically, but several documents reference digital, online, and mobile products that provide credit, lending, or loan services in regulations. In our search, limited to regulatory and policy documents publicly available online in English, we identified 20 regulatory documents specifically mentioning digital/online credit/lending, from 16 countries and one jurisdiction.

Table 1. Regulatory Documents Identified

Regulating Market Conduct of Digital Credit Providers

Market conduct regulations aim to direct the competitive conduct of providers in the market and protect the consumer from unfair practices. In many countries, existing regulations may be applied to digital credit providers, but in some cases the unique characteristics of digital credit may require specific regulation. Twelve of the documents we reviewed addressed issues related to provider markets conduct, targeting data management and privacy, product disclosure, customer redress, consumer over-indebtedness, and rates and pricing (Table 2).

Table 2. Regulatory Documents Reviewed that Address Digital Credit Market Conduct, By Issue

The German International Development Agency (GIZ), the Alliance for Financial Inclusion (AFI), and the Center for Financial Inclusion note that the use of alternative data—or non-traditional data sources like mobile money and social media—to score applicants for digital credit is increasingly common, but has also raised concerns around consumer privacy. Data management and privacy was the most commonly addressed issue across all market conduct regulatory documents. While we identified seven countries with regulatory documents targeting data management/privacy that may relate to digital credit, recent efforts to regulate data management within the FinTech (financial technology) sector are viewed by the International Telecommunications Union as still in their infancy. Further, the regulatory documents we identified do not address the design of individual company algorithms and what data they use to make credit decisions, but rather focus on shielding a customer’s information from inappropriate data-sharing to prevent irresponsible use of private data. Product disclosure and transparency issues were identified by AFI as the most important market conduct issue, and these issues target digital credit providers’ sharing of product terms, conditions, fees, and/or mechanisms with customers. Because digital credit products are sometimes characterized by high interest rates relative to other credit options, controlling high digital credit rates is a concern for regulators. However, CGAP argues that regulations that cap interest rates risk stifling innovation in emerging markets.

Managing Systemic Risk

Regulations that address systemic risk aim to protect a lending environment from collapsing. Fifteen of the regulatory documents we identified include regulations related to managing systemic risk, including licensing and reporting requirements, lending prohibitions, regulatory sandboxes, capital requirements, and governance requirements (Table 3).

Table 3. Regulatory Documents Reviewed that Address Digital Credit Systemic Risk, By Issue

Several regulations outline efforts by regulators to monitor digital market activity through defining licensing procedures and outlining the information firms must provide to regulatory agencies on an ongoing basis, beyond more general laws and regulations on financial licensing and reporting requirements such as those mandated in the international Basel Accords. Capital requirements are intended to ensure the financial system is robust, resilient to shocks, and less vulnerable to financial instability, but the Council on Foreign Relations and others note that if capital requirements are too high, these requirements may leave little money for lending, encourage companies to exit the market, restrict market entry, and stifle innovation. Governance requirements are meant to reinforce responsible decision-making and investments in the financial industry, whether digital or non-digital, though some research suggests that the effects are inconclusive or may stifle innovation.

Six regulatory documents included lending prohibitions—regulations that prohibit or limit electronic money (e-money) providers from distributing loans—though the regulatory language is unclear in terms of how lending prohibitions affect the viability of digital credit products in those countries. On the other hand, five regulatory documents establish flexible regulatory sandboxes—frameworks put into place by regulatory agencies that allow FinTech companies to experiment with new products for a limited period of more relaxed regulations. The objective of these regulatory sandboxes is to transform financial markets by encouraging innovative technology development within a moderately controlled environment. Because the regulatory sandboxes are relatively new, these four countries and one jurisdiction—Indonesia Hong Kong, Malaysia, Singapore, and Thailand—are still in the early phase of accepting applications, and information on how markets and regulatory environments are affected is not yet available.

Digital Credit Regulatory Challenges

The regulatory sphere for digital credit products is still nascent, though multiple groups including AFI, GIZ, the University of Hong Kong Faculty of Law, and CGAP have discussed issues specific to the industry. It is also unclear how digital credit will affect current loan platforms and lenders. Most research and commentary on digital credit, such as reports from AFI, CGAP, and Financial Sector Deepening Africa (FSD Africa), has focused on the potential to create new loans for unbanked populations, but the extent to which digital credit is creating new loans or substituting for existing loans is not clear.

For digital credit regulators, the speed of growth in the industry is a major challenge as noted by the University of Hong Kong Faculty of Law. Though multiple countries are attempting to license non-bank or internet-based financial companies, this is often only accomplished after companies are already operating and putting pressure on the financial system with a large number of products and borrowers. Some countries and jurisdictions have created regulatory sandboxes to build up their FinTech (and potentially their digital credit) start-ups and regulate growth in the industry, while others have imposed regulations only after letting companies develop for a period of time. Regardless, the pace of technological innovation ensures that regulators will have less time than in previous decades to understand and respond to the implications of emerging credit alternatives.

This is the second in a two-part series reviewing digital credit products and potential regulations, presenting findings from EPAR Technical Reports #351a and 351b. In part one we examined product features of 68 digital credit products identified in India, Kenya, Nigeria, Tanzania, and Uganda.

By Kirby Callaway 

Summarizing research by Travis Reynolds, Marieka Klawitter, Leigh Anderson, Pierre Biscaye, Kirby Callaway, Melissa Greenaway, Daniel Lunchick-Seymour, and Max McDonald