We discuss emerging consumer risks posed by nano-loans through the frame of the Client Protection Principles.

> Posted by Alex Rizzi, Senior Director, The Smart Campaign

As champions for financial inclusion, the Smart Campaign is excited about the potential of nano-loans—small value loans, delivered through mobile phones, with a large concentration of deployments in East Africa. Nano-loans are available nearly instantaneously, leverage non-traditional data for underwriting, and can be disbursed and collected with minimal human interaction. These tiny loans can help underserved customer segments access credit, as well as meet short-term liquidity crunches. But as consumer protection advocates, we also want to ensure that these loans are delivered with quality and respect, and do not cause harm to consumers.

Our latest Brief, Tiny Loans, Big Questions: Client Protection in Mobile Consumer Credit, we analyze the consumer risks and opportunities in mobile credit. Using the Client Protection Principles (CPPs), the industry framework that is also the foundation for the Smart Campaign’s work, we lay out the discrete and disparate pieces of evidence to present a more comprehensive framework for responsible mobile credit. The brief leverages observations from our own research on mobile credit providers, as well as a plethora of demand-side evidence coming out of CGAP, MicroSave, the newly launched Digital Credit Observatory, and other sources. Admittedly, most of the evidence is from East Africa, and we would welcome additional sources and research to provide a more global picture.

As consumer protection advocates, we want to ensure that nano-loans are delivered with quality and respect, and do not cause harm to consumers.

The brief includes the phrase “Big Questions,” and indeed it raises more queries than provides answers.  After citing the evidence available, the section on each CPP concludes in a series of questions and provider calls-to-action—for more research, more data and more work to define good practice. Here are a few examples:

  • Appropriate Product Design: Some documentation of risks exists, such as aggressive sales via mobile phone, but more thorough evidence is needed. There is no consensus on what constitutes good practices among providers. We would like to see more examples of providers that set policies regarding product suitability and leverage their technology platforms to monitor, segment and adjust their product offerings, and incorporate feedback from clients into product design.
  • Prevention of Over-indebtedness: Industry discussion is needed on best practices on the use of data on repayment capacity, by loan size. We would also like to see more glossaries that explain, in laymen terms, the variables used for underwriting and why some are better than others (without revealing the secrets of any provider). Research on developing a stress assessment component to underwriting algorithms would ensure that the loan does not add undue stress to the client. Digital lenders should also make real-time credit reporting and information-sharing a priority. This would catalyze a leapfrogging of traditional credit bureaus, which have been historically weak in many markets. Incentives (and regulation) would need to be aligned for such schemes to work.
  • Transparency: Work is needed to help providers figure out how to transparently communicate via the mobile interface so that clients truly understand. Clients should also be able to store and save the terms and conditions, which is a challenge considering the limited memory of many feature phones. There is also great promise for building customers’ financial capability using the mobile interface, though more work is needed.

If we don’t define and implement mobile credit consumer protection best practices, we risk damaging consumer trust, regulatory clampdowns and over-indebtedness crises.

If as an industry we don’t work hard to define good practices and incentivize providers, we open ourselves to risks on several fronts—not fulfilling the promise of these products for consumers, damaging trusting relationships between clients and responsible lenders, regulatory clamp-downs that don’t discriminate between good and bad players, and over-indebtedness crises.

We feel there is real opportunity for providers to invest in client protection today. It’s not just the right thing to do by clients, but it will also help providers distinguish themselves among an ever-growing field of competitors; investors that want to back responsible players; regulators who walk the tricky line of fostering innovation and good market conduct; and ultimately among clients who vote with their feet – or in this case with their phones.

The Smart Campaign is committed to working with providers and the industry to help advance good practice. Email Alex Rizzi, follow #FintechProtects on Twitter, or to learn more about how you can get involved.