Alternative lending in Kenya

While developed regions such as Europe and the United States have been progressively transitioning from traditional banking to mobile payments, Kenyans have been focused on such solutions for years. Kenya, in fact, has the highest percentage of mobile money users in the world, which is brought home by the fact that Kenya adopted USSD based mobile payments in 2007.

Before the advent of mobile money, just one out of every three Kenyans had access to financial services. The rest relied only on cash transactions. This was a problem that mobile network operators sought to address, and it became a great opportunity for them to positively change the way Africans manage their money.

The introduction of mobile money to Kenya increased financial inclusion in Kenya and now Kenyans with no access to bank accounts are still able to receive financial services like credit through their handset devices. As a result of this, alternative lending institutions are now gaining traction in the local financial services, posing a significant threat to traditional lenders such as banks.

An alternative lender is one that provides business loans and financing beyond the traditional forms and can look beyond traditional measurements of success. Alternative business lending makes it easier for growing businesses to get access to the capital they need, especially those businesses that are unable to break through into more traditional models of financing.

According to Statista, the total transaction value in the Alternative Lending segment is projected to reach Sh4.9 billion this year. In every market, there are hundreds of Fintechs trying to provide better services to end customers, and each market has its own unique attributes and will ultimately have different customer solutions.

Kenya’s alternative lending scene has grown rapidly since the mid-2010s, culminating in the establishment of the Digital Lenders Association of Kenya in 2019 by a group of fintech companies. There are currently over twenty alternative lenders operating in Kenya.

The capacity of these alternative lenders to use technology to deliver efficient and effective lending services to underserved businesses and individuals has allowed them to break into the market and succeed. In the banking business, the number of alternative lenders and technologically savvy nonbanks is growing, putting pressure on established financial institutions to digitize their own lending choices.

The picture is not all rosy however as the lenders themselves face risks when entering a market like Kenya. The most common, risk-based challenge facing alternative lenders in Kenya is the stiff competition within the ecosystem.

According to Daniel Goldfarb, the CEO of Lendable, a Kenya based alternative lender in the fintech space, Kenya’s alternative lending scene is cut-throat and this poses a few challenges in terms of sustainability of innovation.

“Kenya is such a competitive market, that we see fintechs needing to rush to market, sometimes before their product or business is ready,” said Goldfarb.

“In many sectors, we have seen players competing on price or over sales representatives in a way that ultimately undermines their business model. This competition however is ultimately good for borrowers, because it increases product innovation and lowers costs,” he added.

An additional challenge faced in the sector is the fact that many businesses and consumers also lack data that loan originators can use to evaluate creditworthiness. This problem is especially acute in emerging markets. This data is necessary when the traditional financial sector excludes SMEs and informal businesses.

There is however cause for optimism, as according to Goldfarb, the alternative lending scene is also forging a new path through the use of embedded finance.

“We see companies increasingly trying to innovate on providing payments and credit to MSMEs and believe there will be some big successes in that sector. We are also very excited about embedded finance through which companies provide a valuable technology service; such as distribution automation, and then provide credit on top,” said Goldfarb.

A common question asked to alternative lenders is how they source their funding to be able to sustain the ability to lend within their markets.

Some of the ways alternative lenders have been able to raise capital is through the intervention of Venture Capital firms that seek to invest in solutions that enhance the financial health of their customers.

Efayomi Carr, Principal at Flourish Ventures, an impact-focused Venture Capital with operations across Africa, noted that the approach used by alternative lending fintechs is quite unique.

“Lendable’s approach couples a data-driven approach to analyzing SMEs with constant feedback and support from companies in emerging markets,” said Carr.

“This engagement underscores why such fintechs are able to understand emerging markets businesses while providing useful insights,” he added.

A key theme that emerges from the alternative lending scene is the importance of alternative lending firm building a track record that involves strong data analytics and high-touch interactions with loan recipients.

This approach is necessary in Kenya and across many emerging markets as it is the most accurate way of determining the risk level of the potential loan recipients, therefore creating a strong relationship between the lender and the recipient of the funds.

The size of the alternative lending industry is set to grow more in the coming years as the sub-sector matures in its understanding of customer’s needs while constantly innovating for sustainable financial inclusion and growth.

More companies are developing ways to use alternative data to make credit decisions and also users now have more data points due to technology.

This bodes well for Kenya’s underserved and underbanked as their overall financial health will be positively impacted.