| Abstract: |
The demand for digital financial services has risen significantly over recent
years. The COVID-19 pandemic has accelerated this trend and since the focus
has shifted towards economic recovery, digital lending has become central.
Digital credit products exploit traditional and alternative financial and
non-financial data to provide access to finance for households and micro,
small and medium enterprises (MSMEs). While it makes lending more inclusive
for underserved or unserved households and firms, its increasing influence
also brings forth challenges that need to be addressed by policy-makers and
regulators in order to guarantee well-functioning credit markets and broader
financial systems that foster sustainable economic development. A central
concern is the adverse effect of digital lending on the stability and
integrity of credit markets (and potentially the wider financial systems). The
rise in non-performing loans, even before the COVID-19 crisis, has been
associated with an increase in digital credits. New players with little
experience enter the market and exploit regulatory arbitrage, but often these
players have no (or only a partial) obligation to report to respective systems
for sharing credit information or to supervisory bodies, which introduces
severe vulnerabilities. In addition, the low entry threshold of digital
financial products, due to their convenience and simplicity for customers,
provides fertile ground for exploitative financialisation. Underserved
households and MSMEs with limited financial literacy may be lured into taking
up unsuitable and unaffordable digital credits, leading to over-indebtedness
and bankruptcy. The last challenge arises from significantly shorter loan
maturities in MSME lending if current forms of digital lending are scaled up.
This is problematic, as firms need loans with longer maturities to realise
productivity-enhancing medium- and long-term investments, many of which
include complementary investments in labour, thereby contributing to an
improvement in job quality. Governments and regulators need to strike a
balance between leveraging the potential of digital lending for inclusive
finance and economic recovery from the COVID-19 crisis, and mitigating
associated risks. In particular, they should, together with providers of
technical and financial development cooperation, consider the following: -
Fostering the integrity of (digital) credit markets. Regulators should
establish specific licenses and regulations for all digital financial service
providers, and introduce obligatory reporting requirements to supervisory
bodies and national systems for sharing credit information. - Preventing
exploitative financialisation. Regulators need to require digital lenders to
present the costs and risks of their loan products in a manner comprehensible
to consumers with little financial literacy, and extend consumer protection
policies to digital financial services. - Ensuring availability of loans with
longer maturities. Development finance institutions and other national and
international promoters of (M)SMEs should assist local banks in the provision
of longer-term loans, e.g. by offering respective funds or partial credit
guarantees. - Establishing regulatory sandboxes. Regulators should launch
regulatory sandboxes to test legislation in a closed setting and to learn
about risks without hindering innovation. |