Imagine a small kiosk (Souq) in rural Ethiopia that requires working capital or a capital loan to conduct or expand its day-to-day operations.
This means that the kiosk owner must go to the nearest commercial bank or microfinance institution (MFI), which may be a long distance away because most bank branches are in urban and peri-urban areas, request a loan from the bank branch’s loan officer, pledge collateral, and wait up to three months for the loan application to be approved. This process is very time-consuming and isn’t efficient for the kiosk owner to loan.
To that end, with the rise of financial digitization, providing credit through digital channels is increasingly becoming the norm in several countries around the world, with China and Kenya serving as examples.
Digital credit providers typically use financial and non-financial data points about the required individual in making decisions, hence creditworthiness of the individual (the ability and availability for credit), is decided within minutes of the loan application on the digital channel. Most digital lending platforms back their algorithms to do the ‘job’ for them in terms of creditworthiness assessment and don’t usually require collateral for loans.
The Ethiopian legal framework states that commercial banks and mobile money platforms that partner with commercial banks can provide credit digitally.
Some of the notable examples of digital credit in Ethiopia are Michu, a credit score-based digital lending platform for micro, small and medium enterprises (MSMEs) by the Cooperative Bank of Oromia; and Tele-birr Mela, Telebirr’s microloan service in partnership with Dashen Bank, which allows users to take out small loans without collateral based on their credit score. In the first two months of its launch, Tele-Bir Mela provided around 157 million birr to around 50,000 clients.
These two digital lending platforms are currently providing micro-loans, with Michu lending a maximum of 30,000 birr while Telebirr Mela has a cap of 100,000 birr for businesses.
Several advantages come from increasing digital credit for both the supply (banks, MFIs) and demand side (individuals or SMEs). For banks or mobile-money operators, having a digital credit platform will increase their customer base, expand their loan accounts and reduce the costs of providing loans.
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As observed with the Commercial Bank of Africa, a bank that provides digital credit M-Shwari in partnership with Safaricom, the number of borrowers lending from CBA increased from 13,000 in 2012, the year M-Shwari started, to around 10 million borrowers in three years. Such an increase can help banks transform their operations from banks serving corporate clients to a bank that can also lend to farmers and deep-rural areas with reduced costs for the commercial bank.
Customers who were previously underserved by commercial banks and MFIs are now served and have access to credit thanks to the availability of digital credit. If users of Digital Credit applications have high credit scores, this will translate into easier access to credit, which will be helpful for small firms looking for working capital or capital investments.
The main disadvantage of digital credit is a higher rate of credit defaults by customers. According to studies conducted in various countries, mobile money platforms that provide credit and neo-banks (digital-only banking platforms) have a higher ratio of non-performing loans than the commercial bank industrial average.
Other drawbacks include data privacy concerns regarding the sharing of non-financial personal information by credit reference agencies with commercial banks, higher interest rates, and the rise in sports betting addiction as seen in Kenya. A study from 2019 shows that most young men use credit from mobile money or neo-bank platforms to bet on sporting events.
As seen with MyBank, since 2015, more than 20 million SMEs have benefited from the availability of digital credit, closing the SME financing gap for Chinese SMEs by almost 70 billion USD, with the majority of the loans being bigger in loan sizes than those currently served in Ethiopia.
According to a recent study done by CIPE, Shega, and Swaye Ventures, the financing gap for MSMEs as of 2020 was 223 billion birr, and the pattern over the years suggests that this gap is likely to grow over the coming years. Expanded digital credit platforms, both in loan size and usage, represent a path to closing the financing gap for Ethiopian MSMEs and providing them a chance to realize their full potential in terms of job creation and economic growth, as expanded credit represents a booming business in most cases.