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The first online lending platforms began emerging roughly two decades ago, and since then, the global digital credit market has grown substantially: It’s projected to reach a value of almost US $72 billion by 2032. The approach has quickly spread across markets, with Africa’s first digital credit product, M-Shwari, launched in Kenya in 2012 as a collaboration between the Commercial Bank of Africa and the mobile network operator Safaricom. Within two years, 2.8 million borrowers had taken out more than 20 million M-Shwari loans.

Dozens of new startups and products were soon launched across both developed and developing markets to follow suit. These products often leveraged non-traditional data sources, enabling them to extend credit to people existing outside of (or on the edges of) the formal financial sector. Many in the industry saw the potential of digital credit to expand financial inclusion — and in doing so, reduce poverty, increase economic growth and improve welfare. However, apprehensions quickly emerged, as consumers increasingly faced over-indebtedness, exploitation and scams.

The digital credit market has continued growing, both in size and scope, into the 2020s. Providers are developing new business models, and offering digital loans in new geographies — and all the while, existing digital loan products have gotten larger, disbursing more credit than ever.

As the market looks to build upon this growth in the coming decades, it’s a good time for providers and other sector stakeholders to take stock and ask some key questions: How did we get here? Where do we go next? And what can we learn about building better products that improve people’s financial well-being?

Until recently, we did not have enough high-quality evidence to answer these questions, or to understand the true impacts and risks of the first wave of digital loans. And even as evidence has accumulated, the market has rapidly evolved, complicating efforts to assess these impacts. However, by understanding this evolution and how early digital loans have impacted consumers, we will be better positioned to assess newer forms of digital credit and guide the development of more impactful products.

Supported by the Bill & Melinda Gates Foundation, the Center for Effective Global Action and Innovations for Poverty Action published a synthesis of collaborative research earlier this year that aims to advance this understanding. The report, “Mobile Instant Credit: Impacts, Challenges, and Lessons for Consumer Protection,” draws on research that investigates digital credit and explores approaches that can better protect consumers and support their financial health. It emphasizes the narrower topics of Mobile Instant Credit (MIC) — small, short-term digital loans that are primarily marketed and used for consumption — and airtime loans, which together formed the first wave of credit digitization. As emergent forms of digital credit come to market, the insights from this synthesis can help us understand the landscape and inform the work of digital credit-related policymakers and practitioners more broadly.

The Rapidly Growing Digital Credit Market

When thinking about where the digital credit market is going next, it’s useful to consider how it originated. In many ways, MIC is an evolution of microfinance — i.e., loans targeted to small entrepreneurs who are often excluded from formal banking. Early on, many practitioners believed microfinance could broaden financial inclusion and boost economies. However, evidence would later show that relatively few customers who were offered loans took one, and the impacts of these loans were muted, dampening enthusiasm and implying that the products were not well-suited to these customers’ broad array of needs.

Meanwhile, by the 2010s, mobile money had become enormously popular, creating the infrastructure and phone-use data which would be necessary for digital credit. Delivering credit through a digital interface reduced costs and enabled smaller loans, which in turn made digital loans more accessible to low-income consumers. Studies on digital loans have shown that customers are up to twice as likely to accept these loan offers, compared to prospective borrowers in similar studies on microfinance. Greater accessibility and ease of use for consumers are two factors that help explain how mobile instant credit has grown so quickly relative to microfinance. More than half of borrowers in a study in Malawi, for example, reported taking a MIC loan because they had money coming soon but wanted to make a purchase immediately, or because they found the loan more accessible despite having money for a purchase.

Importantly, this uptake isn’t just a case of existing borrowers switching to digital loans: New borrowers are being brought into the financial system via MIC. For example, a study in Nigeria randomly approved some digital loan applicants, irrespective of their creditworthiness. It found that those borrowers who otherwise may have been rejected by a financial service provider were 37 percentage points more likely to take out a loan from any source, after receiving this initial loan. They had higher rates of formal borrowing and lower rates of borrowing from friends, family or moneylenders. 

These findings suggest that increased MIC access could enable investment and growth. But as other research has shown, it can also enable over-borrowing, and lead to more customers being locked out of the financial system. 

Causes for Concern as Mobile Instant Credit Grows

As Mobile Instant Credit has become more popular, reports of misconduct, scams and over-indebtedness have become more common. Fear has grown that MIC may undermine, rather than build, the financial health and resilience of low-income consumers. Despite these concerns, rigorous causal studies have not found negative average impacts, and the existing body of research points to modest positive impacts on welfare — most notably an increase in subjective well-being. At the same time, robust descriptive evidence has shown that widespread concern about negative impacts was not unjustified, as rapidly digitizing credit is associated with a rise in a broad set of consumer harms.

The apparent contradiction between these findings highlights the value of diverse research methods. It appears that some borrowers benefit while others are harmed, and these effects roughly balance each other out. So although the average consumer’s financial health has not been impacted, the rapid growth of MIC and similar products has exposed more people to harm and created opportunities for exploitation.

Moreover, financial and digital literacy is generally lower among people entering the formal financial sector via digital loans, and thus these borrowers are at higher risk of being exploited or becoming burdened by debt. In the previously cited study from Malawi, for example, although 90% of borrowers were satisfied with their loan, only 29% knew what the loan fee/interest rate would be, while 47% knew the repayment date, and 46% knew that there was a late fee. Similarly, a study in an anonymous East African country found that people with a longer borrowing history and those who took smaller loans were more likely to repay, and a study in Mexico found that first-time borrowers were 45% more likely to default than repeat borrowers.

As these findings show, though one of the initial promises of digital credit was its potential to boost financial inclusion, the people entering the financial system via MIC are those most susceptible to fraud and exploitation. With proper consumer protections, governments can minimize these harms while reaping the benefits of a more financialized economy, leveraging digital loans as a tool to empower borrowers.

The Future of Digital Credit

Even as the research community has generated evidence on early digital credit products like MIC, new digital loan products are growing at an increasingly rapid rate. For example, Safaricom launched a new mobile money overdraft facility called Fuliza in January 2019, and by 2021, it had surpassed M-Shwari in active users. (For context, overdraft facilities allow transactions despite insufficient funds, and essentially serve as a type of revolving loan). Fuliza has grown as rapidly as any other digital loan product on the market, but we currently lack the evidence base to assess how this different product design might affect borrowers’ well-being in the short- and medium-term.

Other product types such as Buy Now, Pay Later and PayGo are also growing rapidly, but as with MIC products, it appears that consumers do not fully understand the loan terms, leaving them vulnerable to a host of consumer protection risks. The increasing use of digital lending models across sectors, from agricultural finance to MSMEs, begs the question of where we’re heading.

If we maintain the current course, products may become designed for more productive uses — like business credit or loans to improve housing. Yet until providers are comfortable offering much larger loans, these products are unlikely to catalyze broader growth or boost welfare. Given that digitizing credit has had a negligible positive impact on consumer welfare so far, this implies that even if credit markets grow bigger, this growth would fail to more systematically improve welfare and could result in greater harm as these services scale. If future waves of digital credit are to provide safer and more transformative solutions than the first, commercial product design and regulatory capacity will both need to advance beyond the current path.

Fortunately, a handful of pilot projects and studies point to interventions which could address consumer protection. New data sources and collection methods — including social media data, app metadata, mobile phone surveys and mystery shopping — could be combined with advanced analytics to improve market monitoring and enable regulators to move towards preventative solutions. Pairing these approaches with more robust consumer credit bureaus and clearer guidance on the collection and use of sensitive consumer data could help limit predatory lending and improve data quality. This would create a healthier market, with more trust and better data to guide lending decisions, which could give lenders the confidence to offer the type of larger, production-oriented loans that we believe are needed to unlock the full potential of digitization and create better consumer outcomes.

The Case for Optimism

The existing evidence suggests that the welfare impacts of digitizing credit have been muted and the potential for consumer harms has risen, but there is still cause for optimism. Underlying MIC’s rapid growth are genuine technological innovations which have separated it from microfinance and other traditional loan products. To date, these advances have largely been directed towards small consumer loans, and the accompanying regulations and market infrastructure have not yet fully developed.

It is still possible for the industry to shift focus, with providers designing accessible loan products for productive use cases, and regulators building out their capacity to provide proactive and consistent oversight. This could enable people to invest in themselves, their businesses and their communities, generating real gains in welfare and fulfilling the potential that proponents first saw in M-Shwari more than a decade ago. Whether the future of digital credit improves upon initial efforts, providing safer and more transformative solutions, will depend on the evolution of commercial product design and public policy to safeguard consumer protections. We hope that “Mobile Instant Credit: Impacts, Challenges, and Lessons for Consumer Protection” can help inform this evolution, by gathering existing evidence on the relationship between the digitization of credit and development, while establishing key areas where further research is needed.

Dan Cassara formerly supported financial inclusion programs at CEGA.

Photo credit: Joshua Sortino