Back in the 1990s, consumers in developed economies, especially the US, fell into a borrowing pattern where they would use debt on one credit card to pay off another, rotating their credit cards during the course of each month to manage their precarious financial situation.
This pattern of revolving credit to maintain personal financial resilience was the product of a system where financiers wrapped consumer debt around every possible asset and income stream (student loans, car loans, mortgages – some employers even paid salaries straight into prepaid debit cards). Scholars of the 2008 financial crisis, such as Andrew Ross, describe the system as a ‘creditocracy’ that resulted in mass debt bondage.
Debt spiral
In sub-Saharan Africa, a similar pattern of spiralling individual indebtedness has started to emerge. Technology is changing the micro-credit lending market rapidly, with digital lending becoming immensely popular. In September 2018, for example, Kenya’s two main app stores had around 110 mobile loan apps developed by 74 digital lenders; by April 2019, another 47 of the apps had been developed, although 65 had been pulled down.
The good news is that digital credit expands financial inclusion by giving easy access to credit. A 2018 report titled Tech-enabled lending in Africa from non-profit organisation FSD Kenya, found that the money from digital credit is mainly used for meeting day-to-day household needs, for purchasing airtime, or for business purposes such as investment or payroll, in that order; buying personal household goods, paying a bill, meeting medical needs and covering school/university expenses also figured.
Just like credit card consumers in the 1990s, digital credit consumers are paying off one debt by incurring another
And this is where the idea of creditocracy returns. Just like credit card consumers in the 1990s, digital credit consumers are paying off one debt by incurring another. The loans go predominantly to households trying to manage financial precariousness and sometimes to small businesses financing necessary costs and investment.
Ideally, revolving lending creates disciplined borrowers: by taking out another loan to settle an outstanding debt, borrowers improve their credit scores. But high interest rates have been a major burden on debtors, resulting in their incurring late-repayment fees and driving up the loan default rate.
A study in Uganda found a loan product to have an average loan size of US$400, repaid over nine months at a 40% annual interest rate. In Kenya, the annual percentage rate is more than 49%, according to an FSD 2019 report.
Such interest rates make for expensive loans and are helping drive households into the debt bondage of Ross’s creditocracy. A 2017 study of digital credit found that 56% of borrowers in Tanzania and 47% in Kenya had made late repayments, while 31% in Tanzania and 12% in Kenya had defaulted.
If a debt spiral is to be avoided among households in Africa, there is an urgent need for better regulation of digital lending across the continent. Digital lending runs on credit referencing where borrowers’ credit status is rated so as to avoid overborrowing or the risk of borrower indebtedness. But many countries have very weak credit referencing systems, so borrowers are sucked ever further into revolving credit and end up heavily indebted.
This is one of the biggest concerns African countries will be face in the near future. If a solution isn’t found, many households will find themselves locked out of the credit market and unable to access loans. And that, in turn, will seriously affect countries’ efforts to improve the overall wellbeing of households at a macro policy level.
