To Give or Take? The life cycle of digital lenders in Nigeria

Customer deposits may become the game changer

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Fairmoney and Carbon (Formerly Paylater), two of Nigeria’s more recognisable digital lenders have transitioned into full-fledged digital banks. In the early days, Fairmoney and Paylater focused almost exclusively on lending, with consumer deposits taking a back seat. Because only 2% of Nigerians got bank loans in 2020, providing quick uncollateralized loans to customers was an instant hit. As these companies scale, the high cost of capital risk and customer acquisition costs are causing them to accelerate the transition into digital banking and significantly reduce their cost of capital.

Digital lender vs digital bank

Fairmoney grew 1200%, from 100K users in 2017 to 1.3M users in 2021, processing 6.5M loan applications within the same period. Carbon had equally impressive numbers, reaching 2.2M customers in 2019. This growth is important because in the lending space, increasing your customers also means growing your loan book. So while these companies were giving banks a run for their money in retail lending, one crucial differentiator was that most of their lending didn’t come from customer deposits, but from investor money and debt. While digital banks can borrow cheaply from Development Finance Institutions (DFIs), it still doesn’t compare to having access to low-cost deposits—think monies in savings and current accounts. In the end, it’s a tale as old as time: no matter how carefully you arrange your financing, nothing beats lending from customer deposits. 

What do you do when your cost of financing is high? Focus on keeping default rates low. It sounds simple at first, but digital lenders soon find that lending to people you don’t have a tonne of data on is tricky. So they often have to spend a few years refining their lending decisions. Of course, their traditional counterparts that have a ton of data points are certainly not in a hurry to share. Refining loan decisions and managing a high cost of capital over the years may have made digital lenders pickier. It has also made digital lenders stagger their loans—customers are often asked to take out small loans ranging from N10-20k before they can access bigger loans. 

Another question worth asking is how much it costs digital lenders to acquire these customers. Different companies measure it differently but most digital lenders prefer to use a metric called Cost Per Loan, which takes the rejection rate and the number of loans it rejects into consideration. In reality, Customer Acquisition Cost sits around $11-$12 dollars.

While digital lenders have improved their loan decisions and customer acquisition cost over the years, there are no perfect decision systems, so the inherent risks of retail loans are still priced into the interest rates anyway. These relatively high-interest rates also serve as a shock absorber of sorts for the inevitable defaults. It is why some analysts argue that these are subprime loans. The thinking is something like this: if digital banks have figured out their lending decisions, it would reflect in cheaper interest rates. But that’s neither here nor there—after all, they are providing services to a willing buyer. 

Are Customer deposits the gamechanger? 

It’s the classic chicken or the egg problem of what should come first - the customer deposit or the customer loan? Digital banks have always gnawed on this question. Digital banks that have achieved scale now see this as the “circle of life” - anyone who uses your platform to take loans might as well trust you with their deposits. After all, they have to open an account with you to get the loan and repay through your digital app as well. Why not let these customers keep their money with you, so you learn more about them, and maybe, lend their money to others in need. Nigerian digital lenders can no longer afford to mull this, they need to (and have) started building the circle of life.

It’s increasingly clear that digital lenders have to focus on bringing in customer deposits–it’s not sustainable to keep using expensive debt and investor money for business. Digital lenders are chasing customer deposits with the same vigor with which they initially chased retail lending  - debit cards delivered in double quick time, slightly better interest rates on deposits than traditional banks, free transactions, zero fees on card services, buy now pay later (our topic for next month), amongst others. 

It will be interesting to see if the digital banks take the sort of aggressive approach of traditional banks in getting customer deposits. After all, for years, legacy banks were infamous for setting deposit targets for all members of staff and employing a dedicated contract staff network to drive deposits. The digital-first banks may not take this approach, but now that they’ve identified customer deposits as critical, what will their aggressive approaches look like?

While we stew on that, here’s a look into our crystal ball of what we expect the future to look like:

1. Digital lenders will increasingly chase customer deposits and we should expect to see them become the primary account for many young Nigerians, especially those entering the job market.

2. Digital lenders will acquire MFB licenses and potentially pursue an offline strategy, using MFBs as a customer acquisition strategy

3. Digital lenders will increasingly struggle to manage defaults and fraud. As they cast a wider net, we expect to see NPLs and fraud rise—most fraudulent transactions occur on web (47%) and mobile (36%)—making digital lenders an easy target, especially in a country with weak data infrastructure.

   

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See you on Sunday!