Funmilayo Odude, Partner, Commercial and Energy Law Practice (CANDELP)

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  • Law and Society

Creating the right environment for digital lending in Nigeria 19 Oct 2023

The inability of many micro, small, and medium enterprises (MSMEs) to access formal financing has aided the growth of digital lending platforms in Nigeria. The traditional form of lending from regulated financial institutions is not a viable source of business financing for a lot of businesses, particularly MSMEs, due to collateral requirements and tedious processes for application and disbursement. Access to finance is thus a huge challenge for the growth of many businesses.

In a bid to improve access to finance, the Central Bank of Nigeria (CBN), with support from the World Bank Group, established a collateral registry and credit reporting system known as the National Collateral Registry (NCR) as a modern credit reporting system to improve access to finance. It was expected that through the use of moveable and reputational collateral, MSMEs would be able to access more formal financing options.

The passage of the Collateral Registry Act 2017 and Credit Reporting Act 2017 enabled the use of movable assets by borrowers to secure formal financing. Credit reporting, through the credit bureaus, ensured that borrowers could leverage credit rating and reputation as an asset and/or collateral to access financing. This resulted in the influx of digital lending platforms that also leveraged these instruments to aid the provision of alternative forms of financing. Many of the digital lenders ride on the back of institutional investors who have an increasing interest in alternative investment opportunities capable of earning higher returns than the traditional fixed-income investments.

Also facilitating digital lending growth is the relatively low and uneven financial inclusion in the country. While the gender gap makes many reports, there are also other indicative factors such as age, education, and the urban-rural divide that restrict access to finance. Thus, despite the challenging terrain, digital lending keeps soaring in the country and has become one of the biggest beneficiaries of the disruption of banking by technology.

There are multiple forms of modern-day digital lending operations and products, ranging from peer-to-peer (P2P) services, small to medium enterprise lending, and BNPL (buy now pay later). The quick and easy access to short-term financing has helped many small and medium enterprises to bridge liquidity gaps, take advantage of business opportunities, and expand their operations.

Digital lending has also greatly helped with the issue of credit concentration, where traditional financing in Nigeria has focused on three major sectors: oil and gas, construction, and government projects. Digital lending provides access to finance to other sectors of the economy, particularly the informal sector. Digital lenders, having more risk appetite than banks, are able to offer products to lower-income groups and the newer generation of the banked. They allow them build credit history with small loans without falling into debt.

Access to credit is important in any economy and is the key to wealth generation. One of the factors that would be responsible for the development of the private sector, especially one with a huge semi-formal and informal economy like Nigeria, is the ability to borrow at affordable interest rates. It is, therefore, not surprising that the ease of access to credit for SMEs is an important index in how the World Bank measures a country’s Ease of Doing Business.

Digital lenders are able to offer financing in faster and more engaging ways than traditional financial institutions, with many financial institutions now integrating digital lending practices into their operations and offerings. They are able to leverage improving connectivity and digital literacy to provide short-term and smaller size loans to MSMEs.

Nigeria follows global trend as digital lending is growing and changing credit markets around the world. Digital lenders are tapping into the increasingly digitised and accessible customer data, advances in analytics and machine learning, and lower-cost digital channels to design and remotely deliver financing products in seconds to an increasingly connected global and integrated market.

However, there are a number of operational, customer-based risks that come with digital lending, some of which are even more pronounced in Nigeria. One example of the risks is over-indebtedness. The ease of access entices many subscribers to take multiple loans, sometimes simultaneously. The algorithms currently used by digital lenders to determine the size of facility and evaluate ability to pay would probably strengthen over time; but in the meantime, many digital lenders struggle with high default rates, especially considering their high interest rates. This has led to aggressive collection efforts, which in turn has attracted the oversight regulation of the Federal Competition and Consumer Protection Commission (FCCPC) and the Nigerian Information and Technology Development Agency (NITDA).

Digital lenders in Nigeria operate, either through licenses issued by the CBN or state-issued moneylender licenses, depending on the scope of their operations and financial products. Many of these operators do not fall under the regulatory supervision of the CBN. Some of them are entirely outside the banking structure and, therefore, lack access to some of the banking infrastructure. One of the ways to aid the development of digital lending in Nigeria is through credit reporting. Credit reputation is a relatively new concept in this jurisdiction particularly to SMEs and it would take a while for credit reporting to be a very effective measure. However, the use of the credit reporting system through the credit bureaus is proving effective in reducing the percentage of default. However, digital lenders globally are racing to adopt newer data sources to assess the credit worthiness of customers. Even when traditional data sources such as credit bureaus are available, the additional data allows deeper insights into customer finance and behaviour. Such data-driven information allows lenders to have the precision to choose potential borrowers better.

The CBN has aided licensed financial institutions in respect of this issue in two ways. The first is through the adoption of open banking and creation of a regulatory framework for open banking through the Operational Guidelines for Open Banking, issued in March 2023. Open banking promotes the sharing of customer-permissioned data between banks and third-party firms. Safe exchange of data under prescribed regulatory framework ensures that businesses have the adequate data to further develop efficiencies within the financial systems while maintaining the protection of such data.

The second major way the CBN is facilitating digital lending is through the Global Standing Instruction (GSI) Scheme introduced by the Bankers Committee and regulated by the apex bank through an operational guidelines it issued in 2020. The GSI allows financial institutions to obtain an instruction from borrowers before disbursement of the facility to debit their accounts in other financial institutions without recourse to them upon default.

These two interventions are, however, not accessible to digital lenders that do not have banking licenses issued by the CBN. Their lack of connection to the NIBSS Instant Payment (NIP) Platform provides operational challenges to the use of the GSI scheme.

There is a more structured regulatory and infrastructural framework for licensed financial institutions that have digital lending platforms and products. By being licensed by the CBN and connected to the NIBSS Instant Payment (NIP) Platform, they can leverage the GSI Scheme and other schemes introduced by the CBN from time to time such as open banking. Many money lending laws in the states are out-dated and do not reflect either current realities or developments in the financial services industry. While this results in less regulatory compliance risks for the operators, it reduces the efficient development of that space.

The attempts at regulating digital lenders are consumer-centric and reactionary to the bad collection practices of the lenders. The FCCPC, NITDA, and Independent Corrupt Practices and other Related Offences Commission (ICPC) inter-agency joint regulatory and enforcement task force (JRETF)’s relationship with digital money lenders has been with a view to curtail the inordinate breach of private data, defamation, cyber-bullying, and other manipulative practices some digital lenders resorted to for collections, as opposed to promoting development of the space. This has led to the establishment of the Limited Interim Regulatory/Registration Framework and Guidelines for Digital Lending 2022, which demands registration from digital lenders in Nigeria. Protection of consumers is commendable, but it does not rectify the problematic enforcement terrain that digital lenders are operating in.

In order to create an enabling environment, the government, as part of its digital initiative should promote a comprehensive regulatory intervention for the growth of digital lending in Nigeria. Digital lenders must develop a way to comply with data privacy laws and regulations on the use of AI/ML-based systems to analyse customers’ data to check creditworthiness and risks. They can either develop their own infrastructure or through engagement and regulation be allowed to connect into the existing infrastructure of financial institutions.

Digital lending has become a dependable credit source for millions of people worldwide. There are many emerging opportunities, especially for frontier markets like Nigeria, to leverage digital lending to improve credit penetration. For example, there is still a huge opportunity in Nigeria for rural lending which is still largely untapped. It provides a huge growth opportunity for the ecommerce sector as well. The enabling environment should be created for its growth and improvement.

Funmilayo Odude is a Partner at Commercial and Energy Law Practice (CANDELP).