Report of the Webinar Series: Digital Credit for COVID-19 Economic Recovery (2020)
Cottage, micro and small enterprises, as well as the informal sector, are the largest contributors to our GDP and employment, and they are hardest hit by the ongoing economic slowdown. But, they have traditionally very limited access to financial services and are less likely to benefit from the government stimulus packages.
In this context, Digital Finance Forum Bangladesh, an association of digital finance, FinTech and inclusion professionals of Bangladesh, has decided to develop a policy/working paper to promote digital credit in Bangladesh in the context of COVID-19 economic crisis and recovery thereof. We intend to explore the potentials of digital credit/lending for these under-served segments of our economy. So, we had arranged an online webinar series during June-July, 2020 on the relevant topics and engaged key stakeholders for valuable input/feedback. We are now working to develop a policy paper and would disseminate the policy recommendations to policymakers in a national conference to be organized later on to facilitate digital credit disbursement by the lender to achieve greater financial inclusion. The ultimate goal is to achieve sustainable development in the financial sector of the country.
The webinar series were jointly organized by Digital Finance Forum Bangladesh, Digital Frontiers Institute, University of Liberal Arts Bangladesh (ULAB), and a2i Program. Brief summary of the webinar series is discussed here.
Background
Despite impressive progress in financial inclusion over the last few years, about half of the adult population of the country are still unbanked with no or very limited access to basic products and services offered by the formal financial institutions. While efforts to promote financial inclusion predominantly have been in the means of providing access to FI account and savings products, COVID-19 has underscored the access to credit for the unbanked population in the times of economic turmoil. On the other hand, access to credit for the cottage, micro, small, and medium enterprises (CMSME) has been a priority in government’s COVID-19 response since these enterprises have been the hardest hit by the economic shutdown. A large number of CMSMEs operate in the informal sector, representing a lion’s share of the country’s 7.81 million enterprises. Hence, severe concern remains whether the vast number of informal enterprises will have access to the COVID-19 recovery loans distributed by the financial institutions.
Digital credit has received growing attention in the COVID-19 context due to its potential to increase access to credit by transforming appraisal, approval, disbursement, and repayment of loans with the use of big data, sophisticated technologies, and innovative channels such as Mobile Financial Services (MFSs). However, digital credit’s relevance and significance in Bangladesh’s socio-economic context goes beyond COVID-19.
Demand for Digital Credit
Historically, serving the cottage, micro, and small enterprises with credit products have been difficult for the financial institutions due to heavy operational costs and process involved. Bangladesh Bank has set out directives to increase share of CMSME loans to 25% of the total loans by 2021. Furthermore, the regulator has introduced 9% interest rate cap and 6% deposit cap starting from April 2020 for all types of loans. Although these regulatory directives provide praiseworthy supports to the CMSME sector, banking sector has felt mounting pressure on them. That loans at 9% interest rate for the CMSMEs pose more risks and costs when compared to corporate loans has been a common argument across the banking sector. As a result, financial institutions are increasingly interested in digital credit, which could streamline their CMSME loan operations and lower the loan maintenance costs significantly. Hence, financial institutions, such as the banks, have started to see digital credit as the inevitable future.
Digital credit in supply chain financing presents a more specific use case in the cottage, micro and small enterprise sector. Small suppliers often cannot join supply chain ecosystem of large conglomerates due to the payment terms set by the latter. Such payment terms directly affect supplier’s cash flow and hence hurt the business overall. Digital credit can expedite supply chain financing for the suppliers and thus can unlock their access to the supply chain ecosystem of large conglomerates.
With the rise of platform business models such as Pathao, Sheba.xyz, etc. in Bangladesh, a new generation of micro-entrepreneurs has joined the so-called gig economy as service providers. 300,000 riders and 5,000 restaurants on Pathao, 50,000 small businesses on Sheba.xyz, 500,000 MSMEs on ShopUp- these numbers could go on to illustrate the size and growth potential of such online platforms. These platforms are heavily reliant on these micro-entrepreneurs and growth of these entrepreneurs are crucial for their sustainability. For these micro-entrepreneurs and small businesses, often underserved and overlooked by formal financial systems, digital credit can unlock their access to credit and help grow their businesses. As a result, few platforms are already on the look out to bring digital credit to the micro-entrepreneurs and small businesses using transaction data residing on the platform and through partnerships with financial institutions.
Avenues for digital credit in microfinance sector have received much attention recently. Accounts from the experts working in this sector reveal that nearly one third of the total loan portfolio (on average BDT BDT 50,000 crore out of BDT 1.5 lac crore) of the microfinance sector are disbursed each year among the cottage, micro, and small enterprises in the form of microenterprise (ME) loans. However, microfinance institutions (MFIs) are often criticized for the high interest rates applied on the bottom of the pyramid population. Digital credit in microfinance sector could transform the loan operations from human-intensive to technology-intensive. As a result, MFIs can bring down the loan operation cost and lower the interest rates. However, the greatest advantage of digital credit in microfinance goes beyond this sector. Graduating from the ME loans provided by the MFIs to bank loans is often challenging due to lack of digital footprints of the cottage, micro and small enterprises. Once digital credit takes effect in this sector, the digital footprints of these enterprises could facilitate their graduation from ME loans to bank loans at much lower interest rates. Hence, digital credit in microfinance sector could have positive spillover effects on the country’s banking sector.
Challenges
Diffusion and adoption of digital credit pose complex set of challenges at all stages of loan operations- starting from customer onboarding and approval to disbursement and repayment. Road to mass deployment of digital credit operations requires building an infrastructure that would facilitate customer onboarding process digitally. While e-KYC has just taken off in financial institutions for individual customers, e-KYC for the purpose of loans is not available yet. Legal barriers and absence of appropriate laws for dispute handling related to digital signature, digital consent, and digital documents impede digital onboarding significantly. Long paper-based loan application process often discourages the cottage, small, and micro entrepreneurs. Accounts from expert suggest that reducing the number of pages of paper-based loan application, from a 14-page to a 2-page application form, significantly increases the likelihood of loan applications among the marginal entrepreneurs. Digital onboarding, with the use of e-KYC and other technologies, could simplify the loan application process further and facilitate the subsequent stages of loan operations.
Lack of digital infrastructure for appraisal and approval of loan applications is a major bottleneck for digital credit deployment. Financial institutions often do not have real-time online access to documents necessary for the credit appraisal and decision. Verification of the bank statement, trade license, land and properties, etc. still requires repetitive physical visits. Furthermore, while banks and non-banking financial institutions can verify the National Identity Cards (NID) electronically, MFIs cannot. Considering the huge segment MFIs serve, a market of 40 million customers, this is a major setback. Digital transformation of MFIs is also equally important to create digital data footprint of the customers which can open up new avenues for offering other financial services for bottom of the pyramid population. Building a digital infrastructure that would enable the financial institutions to verify all types of documents in real-time is a prerequisite for the diffusion of digital credit. Extending the scope of NID cards can facilitate such digital transformation by connecting the data silos residing in servers across governmental institutions, financial and non-financial institutions, and regulators. The Indian example of Aadhaar card and account aggregator could be inspiring in this regard.
Mass acceptance of MFS across the country over the last few years has created a great avenue for the disbursement and repayment of loans. Leveraging the MFS has facilitated speedy disbursement and repayment of loans for financial institutions. However, further transformation of MFS as regular channel for digital credit operations is required. Existing limits on the transaction value and the costs associated with the transaction are bottlenecks for the repayment of loans through MFS. Allowing to receive and repay the loans at reduced costs, irrespective of the ticket size, could facilitate digital credit operations greatly among the cottage, micro, and small enterprises. Moreover, transaction data of more than 800 million MFS wallets can be used as an important component for alternative credit scoring.
Telecom operators have lots of consumer data in their custody which can be utilized to understand consumers’ behavioral pattern. At the same time digital lenders need to know which data they should be extracted. But, Telecommunication Act and License Framework have strict rules to use consumers’ data in very limited purposes and those do not allow to be used to assess credit worthiness. However, we have to examine if data can be shared with third parties upon informed consent of the customers or they can collect their data from the telecom provider and share with other institutions for credit assessment.
CIB of Bangladesh Bank hosts credit history of about five million customers only. CIB of MFIs will bring 40 million customers under the credit bureau and enable to assess credit worthiness of a large population. “Credit Rating Rule-1990” of BSEC needs to be amended in few circumstances to allow credit rating of individual’s. Currently, credit rating agencies are only focused on rating of large corporate entities.
Nano Credit- Need a Cautious Approach
Following the rapid diffusion in several African countries, nano credit has received widespread attention among the developing nations as a tool for providing instant access to credit. Nano credit providers use smart phone data, ranging from airtime usage and social media behavior, to assess the credit worthiness in real-time. Once a credit decision is made using sophisticated algorithms, the disbursement is happen near-instantly though the mobile wallets. These nano credits have small ticket size of typically US$30–50, high interest rates, and have 4 weeks on average as the repayment period.
Nano credit has recently come under intense criticism due to its socio-economic consequences in Kenya and Tanzania. In a survey conducted by Consulting Group to Assist the Poor (CGAP) of World Bank group, 31% of Tanzanias borrowers and 12% of the Kenyan borrowers have been found defaulted. However, the recent data suggests that the default percentages are much higher in both countries. The survey has also found that a significant number of borrowers have taken multiple loans from more than one providers. Debt cycling is common among the borrowers since they often attempt to repay one loan by taking a new one. Nano credits have resulted in financial exclusion, too. Media accounts suggest that majority of the 3.2 million Kenyan blacklisted in 2020 by credit reference bureaus (CRBs) for defaulting were nano credit borrowers. Many of the blacklisted borrowers often owe less than US$9 and are barred from future loans. The instant access to credit has also resulted in increased sports betting among young male Kenyans.
Regulators have started to step in to curb the negative consequences of nano credits in these countries. Allowing nano credit in Bangladesh would require regulatory interventions so that the predatory behaviors of the providers and the negative social consequences are addressed and controlled.
Way Forward
Digital credit has great potential in the CMSME sector where micro, small, and medium enterprises alone account for 25% of country’s GDP and employ 87% of the workforce. As described above, digital credit is relevant for both traditional enterprises and new generation entrepreneurs of online platforms. However, significant transformation and digitization across financial institutions, government agencies, and regulators are required for large-scale diffusion and adoption of digital credit. Accounts from the representatives of government agencies and regulators suggest that many praiseworthy initiatives are being implemented towards building a digital infrastructure in the country. A national portal for the purpose of real-time trade license verification at the city corporation level is underway; a central database of land and property registration documents is being built; and a CIB database for the MFIs is currently in final stage . These infrastructures would greatly facilitate digital credit for the CMSME sector. Nano credit has resulted in negative economic and social consequences in Kenya and Tanzania, but there are good examples, too. Nano credit can be a great instrument for greater financial inclusion and easy access to credit if the borrowers use the loans in productive ways and regulators play their parts. Digital credit is a novel concept across the world, not just for Bangladesh. Regulatory sandboxes participated by all relevant stakeholders including the financial institutions including MFIs, telecommunications companies, MFS, regulators, and government agencies can present responsible digital credit products to both individual customers and CMSMEs of the country.
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