ImpactAlpha, Feb. 13 – “Proceed with caution” in fintech investing was the conclusion of our lookahead at impact investing trends to watch in emerging markets in 2020.
“In Kenya, for example, a proliferation of alternative credit-scoring services are providing first-time borrowers with near-instant access to mobile credit – at the same time usage of gambling apps is soaring among individuals who have secured quick and easy digital credit,” we wrote last month (see, “Where to hunt for impact investments in Africa this year”).
Now, Bloomberg Businessweek paints a fuller picture that recalls the 2010 crisis of microfinance in the Indian state of Andhra Pradesh: “About 2.5 million Kenyans—1 in 10 adults—have defaulted on a digital loan,” the magazine reports. “Others are trapped in a debt cycle, borrowing from one app to pay off another. Last summer newspapers reported that a 25-year-old man from a tea farming village north of Nairobi had hanged himself after defaulting on a $30 loan from an unspecified app.”
New and experimental “alternative credit scoring” models, social and e-commerce platforms, and low interest rates and yields are making borrowing global and digital. Businessweek’s takedown, in particular, of Tala, a digital-lending app that has raised more than $200 million, raises challenging questions about financial services that proclaim “inclusion,” but may instead be enabling predation, a debt bubble and impoverishment of many customers.
Tala has raised five rounds of funding from almost two dozen investors, starting with venture capitalist Chris Sacca and expanding to PayPal Ventures, Steve Case’s Revolution Growth, and Data Collective. Few of Tala’s investors self-identify as “impact funds,” but the company has sought, and received, the imprimatur of ‘financial inclusion’; ImpactAlpha featured Tala’s Shivani Siroya as an Agent of Impact last August.
Bloomberg’s Zeke Faux centers his story around Patricia Lele, who says at first she paid her Tala loans when they came due. “Then Tala boosted her limit, and she took out another to buy more supplies and some food. By spring she was borrowing about $70 a month, almost her entire income.” Then she ended up in the hospital with malaria and typhoid fever. “Then her phone rang. It was a debt collector. Her Tala loan was past due. When Lele said she was in the hospital, the caller told her she didn’t care.”
A MicroSave Consulting study cited in Businessweek found that two-thirds of the loans issued by nonbank lenders are delinquent. One in 10 Kenyans have defaulted on a digital loan; others are borrowing from one app to pay off another.
In a post on its site, Tala says 2019 “was a challenging year for the digital lending industry in Kenya,” with an increasing number of digital-credit providers – and increased indebtedness. It said the company welcomes consumer-safeguard regulations and the code of conduct of the Digital Lenders Association of Kenya. A third-party review of the company’s collections efforts identified some agents that “did not meet Tala’s high standards for customer service and business integrity and we took immediate remediation steps,” the company says.
Today’s emerging-markets fintech boom is rooted in decades of attention to the undisputed need for greater access to financial services for billions of unbanked households. That has been turbocharged by mobile money, smartphones and, significantly, AI-driven credit-scoring algorithms. Suddenly, financial services in low-income, emerging economies has become an interesting mass-market opportunity. Globally, fintech deals reached $24.6 billion through the third-quarter of last year. Andreessen Horowitz is an investor in Branch, founded by Kiva co-founder Matt Flannery, which raised $170 million in April. Sequoia Capital is an active fintech investor, especially in India.
In that context, the enhanced accountability of longtime impact investors represent a set of risk-mitigating best practices that stand to be increasingly valuable to the new wave of fintech investors. An emerging crop of responsible fintech companies are looking at new approaches to helping customers manage and get out of debt. That includes longer-tenure loans, with interest rates that go down over time, and collateralized lending where lenders share risks with borrowers.
“Impact investors need to be careful” to scrutinize the fintechs’ underwriting models, warned Goodwell’s Wim van der Beek.
Two dozen financial services companies (including Tala and Branch) and more than 40 investors have signed onto the Guidelines for Responsible Investing in Digital Financial Services. Practices like avoiding over-indebtedness, designing appropriate products and responsible collecting practices not only protect consumers, but mitigate risk to investors. Not among the signatories: Tala’s lead investors, including PayPal Ventures, Revolution Growth, RPS Ventures, IVP and Data Collective.
Monica Brand Engel of Quona Capital, which invests in inclusive fintech across three funds in sub-Saharan Africa, Latin America, and Asia, says she sees in Kenya signs of India’s microfinance crisis of 2008, which also included reports of overaggressive lending and collecting, and a rash of farmer suicides. “It was partly investor-driven, unsustainable acceleration that drove that disaster,” she says.
In Kenya, she says, no one company or investor is at fault in what’s unfolding. A broken Kenyan credit bureau and underdeveloped debt markets present a challenging environment for financial services. “The risks are real but there are ways to mitigate them,” Engel says. Investors need to pause and ask, “are we growing with quality?”
“The notion that you can just plug-and- play, push on the accelerator, and just spray and pray,” doesn’t travel well from Silicon Valley to sub-Saharan Africa, she says.
Early-stage investor Accion Venture Lab, for example, looks closely at fintech product pricing and how firms use, analyze and protect customer data (Accion offers a data protection toolkit for fintech ventures.)
“The price has to make sense for the customer, and we want to see that they’re offering lower prices over time, not just bigger loans,” Accion’s Vikas Raj tells ImpactAlpha. Raj advocates investors think beyond financial access to responsible access, “where services are leading to financial health,” he says.
Given how much underwriting algorithms are now based on mobile phone data, fintechs have a pretty good sense of whether customers are using other digital lending apps, Raj adds. “We have companies (in our portfolio) that say, if you’re getting a loan from another digital lender, we can’t lend to you.”
Tala’s $110 million raise last year was only one of several that stirred concerns about an Africa “bubble.” After JUMO $70 million capital raise, led by Goldman Sachs in December 2018, medical drone delivery company Zipline scored a whopping $190 million from TPG Growth’s Rise Fund, Temasek, Goldman Sachs and others. Andela, an African tech training and job placement venture, took in $100 million. Digital remittance company WorldRemit raised $175 million in a Series D funding round and off-grid solar companies in Africa raised hundreds of millions of dollars.
“Pressure to deploy ever-larger volumes of capital, coupled with questionable due diligence practices and minimal to no local presence or expertise create the conditions for a correction or market shakeout,” ImpactAlpha wrote Jan. 9.
“It’s a scenario we’ve seen in emerging markets investing before,” Goodwell’s van der Beek observed. “There will be some train smashes in the next few years.”
Dennis Price contributed reporting.