Lenders battle against fraudsters; a case for an industry blacklist

In Kenya, an estimated 3.2 million people — 6% of the population — have been blacklisted on Kenya’s TransUnion credit reference bureau for non-repayment of digital credit loans. Being placed on a blacklist like this means that you won’t take loans from any other lender.

It would also mean that you will be ineligible for post-paid services like pay TV. While there’s a lot of debate as to whether blacklists promote financial exclusion, I believe that it is a useful tool in shaping people’s credit behavior.

Take Nigeria, for instance, where it is taken for granted by prospective lenders that there are no real consequences when you don’t repay a loan. You can draw a straight line from that thought process to why Nigerians often think they don’t have to repay loans.

Yet, it’s not only that people simply don’t repay loans; the rot goes deeper than an industrial borehole, with people formulating complex schemes to defraud lenders. Even as banks and fintech startups make their security processes and RAC more complex, bad actors are usually a few steps ahead.

The scale of the problem is massive. In 2018 alone, the Nigeria Deposit Insurance Commission (NDIC) stated that Nigerian banks lost over ₦15.5 billion ($41.6 million)* to fraud. Most companies choose not to publicize these incidents to scare the investing public or even embarrass themselves. The Nigeria Inter-Bank Settlement System (NIBSS) also reported that the banking industry lost ₦2 billion ($5.5 million) to electronic fraud in 2018.

It is not unusual to hear of customers who take loans from 3 to 5 lenders simultaneously and then disappear into thin air. Recently, we all heard about fraudsters who use stolen identities to get phones with the details of their victims.

The victims often remained blissfully unaware until they were contacted by the lender to repay those bad loans. While we’re still guessing badly hit banks are, it’s difficult to know how much the alternative and fintech lenders also have to contend with.

But here’s something to speak to just how ingenious bad actors are; this report from WeeTracker shows how a small shadowy organization fleeced money from thousands of people using what seemed to be a legitimate Paystack storefront.

These sorts of audacious schemes and a general unwillingness of customers to pay loans have drawn the attention of regulators.

Global Standing Instruction tightens the noose on bad actors.

On July 13, 2020, Nigeria’s Central Bank published the guidelines for Global Standing Instructions (GSI).

In a nutshell, the Global Standing Instruction (GSI) creates a contractual mandate from an individual borrower, in favor of a creditor bank, to apply funds standing to the credit of the borrower in a third-party financial institution or electronic wallet to offset the debt obligations of the borrower.

In Nigeria, the GSI can be easily executed because every bank user has a unique Bank Verification Number (BVN), which is linked to all your accounts. Default on loan will mean that the bank can take the amount owed from any of your other accounts.

While GSI is an important step in introducing real consequences to people who don’t pay loans, there’s no doubt that introducing blacklists is also a necessary second step. It is more important when you consider the amount of non-performing loans lenders have to deal with.

In 2018, the NDIC reported that commercial banks gave out ₦15.29 trillion ($44.16 billion)* in loans to the domestic economy, and by the year’s end, non-performing loans stood at ₦1.79 trillion ($4.9 billion)*.

In spite of the pros of GSI, it has not exactly addressed the problems. For one, GSI is only available to banks, leaving out the digital lenders who also give large loan volumes. This means that while the banks are afforded some protection, digital lenders are not.

Yet, even the banks aren’t falling over themselves to use GSI because to use the mechanism; you must first prove that the loan has gone bad. That caveat has reporting implications for the banks, and we already know that banks and provisions are like oil and water.

It’s time to consider a blacklist.

How blacklists could work

In Kenya, for instance, a credit information sharing (CIS) mechanism helps lenders share information about lenders with each other. When defaults happen, the names of those lenders are shared with the Credit reference bureaus (CRBs).

But this process is tied to credit history and could become somewhat complex. Blacklists are more straightforward because they block bad actors who have committed acts of fraud or identity theft. When this happens, it becomes impossible for the blacklisted person to take a loan from other lenders.

This distinction is important because while credit bureaus have their uses, they don’t exactly provide consequences for bad behavior. In Nigeria, there are only three national credit bureaus licensed by the Central Bank of Nigeria: CreditRegistry, FirstCentral Credit Bureau, and CRC Credit Bureau.

These bureaus check for lending history and calculate credit scores using their proprietary scoring algorithms, which lenders then use to determine the customer’s capacity to take loans and willingness to repay. While it is useful, it creates no disincentives and consequences for people who deliberately game the system.

The issue with credit bureaus is an unfortunate one for Nigeria, though. The reason is that over 90% of individual borrowers don’t have a credit history. You would then ask why the lenders don’t give their data to the credit bureaus. The biggest drag has always been that credit bureaus collect data from lenders for free and turn around to sell it to them as rates not sustainable for micro and nano loans. In the end, everyone loses, Nigerians being the biggest loser of all as most of us never get access to affordable credit when we need it.

These attempts to game the system through illegal can, at best, make lenders wary of giving loans to customers and, at worst, can put some lenders out of business. So the primary argument for blacklists is that they can help shape behavior by showing that illegal behavior will not be rewarded.

Changing the mindset around repaying loans is important. When you consider that there have been no significant consequences for failing to repay for years, it is clear that it will take a while as well as disincentives to get defaulters and bad actors to fall in line.

One other big advantage to blacklists is that they will lead to cheaper loans because lenders will no longer have a need to factor in expensive risk premiums in their risk models for the increased risk levels. All of these benefits from a simple solution feel like a bargain. Furthermore, we can see lenders tweaking their Risk Acceptance Criteria (RAC) to be less onerous.

There are already existing frameworks for blacklists, such as Karma.ng from Lendsqr, and it will help keep the bad guys out. But so far, the willingness of lenders to embrace these means of protection has been lukewarm at best. However, as the market evolves, blacklists will provide more competitive advantages to lenders than even the best of algorithms; while guess, no matter how sophisticated it is, when you can use actual data to bar the bad actors.