If you’ve ever borrowed an emergency fund from one of the multitudes of digital lenders available online, the one thing you must have noticed is the high interest rates most of them charge on short-term personal loans.
The average loan app in Nigeria will charge you anywhere between 10% – 20% for a 14 day loan, some even charge the same interest rate on a 7 day loan tenure. And for longer term loans of upto 6 months, expect the average lender to charge you 48% — 120% interest rate.
To understand why these lenders charge such ridiculously high interest rates, you need to understand how they make and spend their profits.
First, online lenders are not charities. They are businesses operated by real people even though you might not be able to see or interact with them on a regular basis. They have to pay their staff, pay for Credit Bureau subscription to be able to weed out borrowers who have a history of defaulting on loans, they have to pay for and maintain the app and web interface that their businesses run on. They also have to pay for advertising and office space among other expenses.
In addition to all these they also have to contend with the disappointing fact that most Nigerians simply do not payback their loans and end up using a proportion of the revenue generated from interest on loans to cover the cost of the few borrowers that won’t pay back.
To the point that most Nigerians don’t pay back their loans – think of the economy as an intricately connected system. Say a man took a loan of N100,000 with the hope of improving his business. But on getting home he found his child sick and in need of medications. Due to the poor state of the Nigerian economy and the fact that most Nigerian families don’t have health insurance, he ended up using the loan to cater for his child, after all life is more important. Such a man would definitely default on their loans and won’t be able to payback. This is just one example of the many things that causes people to default on their loans in Nigeria.
The main driver of high interest rates in Nigeria is the risk associated with lending money to Nigerians. Way too many things can go wrong leaving the lender unable to recover their loans.
Let’s look at a typical lender’s money journey.
Let’s say Janet, the founder of XYZCash, took a deposit of N10 million from investors, at 15% per year, which commits her to returning N11.5 million at the end of the year. Some of the investors are family, friends, and people introduced to her by her uncle.
XYZCash follows to disburse the N10 million in loans to their customers and channels the interest repaid on the loans towards making returns to investors and covering their cost of operation. The interest charged on loans also caters for expected profit; lending businesses, not being run as charity organizations, are out to make profit from solving a problem.
Let’s go further and imagine XYZCash gave N10,000,000 to 100 borrowers and about 10 didn’t pay back; this implies the actual value of loans they would generate interest on is N9 million — N1 million naira is lost to bad loans. Additionally, if they need 15% for operational costs and the added 15% as return to investors, this leaves them with an additional 14% (approx.) on the original amount they have to generate just to break-even.
The high interest rates charged by loan apps has a lot to do with the poor state of the Nigerian economy which in turn makes most Nigerians high risk borrowers. In addition to their operating costs, these lenders too would very much like to make some profit which they can’t do unless they charge high interest rates to cover for those who will default.