[From Brookings Institution´s Tech Tank blog, 22 January 2015]
Recent reports have highlighted how mobile-based financial services are transforming banking and payments in Kenya, Bangladesh, and Peru, and all the hype about how they are about to explode everywhere else. For all of the promise that digital financial systems have for lowering costs and helping people all over the globe, it is unfortunate that their development is hampered by regulation that protects the interests of the largest providers. These regulations create significant barriers and raise the total costs to achieve universal financial inclusion.
It is indeed conceivable that purely digital financial transactions could be handled at vanishingly small unit costs, from anywhere. But the cost that won´t go away is that at the interface between the new digital payment system and the legacy payment system – hard cash. Cash in/cash out (CICO) points are like tollgates at the edge of the digital payments cloud.
Cash is Still King
Even in areas with flourishing mobile banking usage, people tend to cash in every time they want to make a mobile payment, and to cash out immediately and in full every time they receive digital money. Rather than displacing cash, digital platforms have made local cash ecosystems more efficient. Without full backward compatibility with cash, digital payment systems could not take root.
The bigger issue is not the size of the CICO toll, but the fact that small players cannot expect to have the transaction volume to sustain a widespread CICO network. The incumbent banks and telecommunications firms have built in competitive advantages. They can quickly form agreements with brick and mortar shops, attract users from the current customer base, threaten new entrants, and aggregate enough transactions to induce CICO outlets to maintain sufficient liquidity on hand.
Therefore, the competition in digital financial services will not be determined primarily by what happens within the digital payments market itself, but rather by what happens in the contiguous cash market. The power of digital services is their ability to transcend geography, and yet success in the digital payments space will go to whoever has the best physical CICO footprint.
Regulators treat the digital payments service and the CICO service as conjoined twins: each digital financial service provider must have its own base of contractually bound CICO outlets. When the two services are bundled it is not surprising that the tough economics of CICO —and, therefore, the incumbent— dominates.
A Two Market Regulatory Approach
In a recent paper, I argue it is necessary to split up these two markets, from a regulatory point of view. The market for effecting electronic payments (issuing payment instructions and debiting and crediting electronic accounts accordingly) is logically distinct from the market for exchanging two forms of money (hard cash versus electronic value).
Most regulators approve of stores receiving electronic money from customers in exchange for packs of rice on a store shelf. But, if that same electronic money was exchanged for cash then it would violate the law in many countries.
In the latter case, the store is presumed to be an agent of the customer’s financial service provider, and the store cannot offer the CICO service without an agency contract from that provider. But why? The cash that was offered was the store’s as is the account that would receive the electronic payment, and the transaction would have occurred entirely through a secure, real-time technology platform that banks offer all their clients.
A Regulatory Fix
Of course, purely financial transactions are usually held to higher consumer protection standards than normal commercial transactions. My proposal is not to deregulate CICO, but to create a new license type for CICO network managers. Holders of this license would carry certain consumer protection obligations (such as ensuring that tariffs are explicitly posted at all CICO outlets, and that they have a call center to handle any complaints that customers may have on individual CICO outlets) – entirely reasonable expectations for retailers, even if we normally don´t ask them of rice sellers.
But once you have a CICO license, then you could sign up any store you wanted and crucially, offer CICO services on the platform of any financial institution in which you have an account. In other words, you wouldn’t have to beg the incumbent to give you a special agent contract. All you would need to do is to open a normal customer account with them, which the incumbent couldn´t deny you.
This one little change would completely shift the competitive dynamics of digital financial services. Under the current direct agency model, incumbent firms have no incentive to make it easier for competitors to create CICO outlets. Whereas under the independent CICO network manager model, all licensed CICO networks would have the incentive to offer CICO services for all providers, no matter their size: with a full suite of available services, they will find it easier to sign up stores to work for them, and these stores will find it easier to convince more users to walk into their stores.
Incumbents would still be free to establish their own proprietary CICO networks, as today. But they would have to compete with independent CICO networks that are now able to aggregate business from all financial service providers, creating true competition.
All players could then claim a comparable physical presence as the incumbent. They would all benefit from the same branded competition between CICO networks. They could compete strictly on the basis of the quality of their digital financial services offering.
Unbundling the regulatory treatment of digital financial services would help competition reach every segment of the business; the current integrated model only serves the interests of the largest telecommunication companies and banks in the land.
[From NexBillion blog, 13 January 2015, with David Porteous]
In Spent: Looking for Change, the recent documentary about financial exclusion in the United States (embedded below), there is a moving segment about a young man named Justin who is determinedly rebuilding his life after having obliterated his credit rating by failing to repay his credit card debt. He says (from the 16:00 mark): “People often judge me on the choices I've made, not knowing the options that I had.” Maybe if we knew the limited options Justin had when he decided not to repay his debt, we would agree with him that he had taken the most appropriate, even responsible, action by not repaying. If that were the case, wouldn´t that make us want to trust him more rather than less? Years later, when his situation and options had changed, we would likely feel positive about offering him a new loan for a new beginning.
Economists say that credit bureaus are about solving information asymmetries between creditors and borrowers. But which asymmetries are the economists talking about, exactly? No credit bureau helps Justin explain to financial institutions that he was forced to scratch out a living entirely on his own from age 16, that his earnings didn´t always last to the end of the month, but that those days are now behind him. All the credit bureaus do is to propagate information on his past non-repayment.
As David Graeber argues compellingly in his sweeping history of money Debt: The First 5000 Years, we now take for granted that all loans must be repaid, fully and on time, as if that was a natural societal imperative - but that has not traditionally been the case. Debt moratoria, renegotiations, substitution for tokens of assets or labor, even wholesale cancellation of debts, are recurring themes everywhere. It is only fairly recently that debt repayments have become an absolute test of character, often summarized in a three digit score. Credit scoring has become something about you, disconnected from your circumstances and options.
With the digitization of finance, we face the daunting prospect of “the system” having an unforgiving and unforgetting memory of poor people´s formal debt repayments while knowing little else of any real significance about them. Credit providers will build a profile of you based on disjointed circumstantial evidence, slowly and painfully crossing datasets, almost accidentally – you have $20 in your savings account, a mobile ARPU of $1.70 per month, demonstrated successful repayment of a $10 instant mobile loan – but you can blow whatever positive attributes you’ve demonstrated all on one unpaid debt. One strike, you´re out. Big Data can become the basis for a new exclusion.
Exclusion is often the result of ignorance. Ignorance creates prejudice: in the absence of concrete information, you generalize. And big data is fundamentally about drawing big generalizations - excuse me, correlations. I can easily believe that these correlations will work increasingly well on average, giving new financial opportunities to many. But in the process, many Justins will be pushed further into financial untouchability, silent casualties of the unfathomable wisdom of the machine. Something that demonstrably works on average may be commercially satisfactory, even socially impactful, but may fall short on inclusiveness – in the sense of helping those who need help the most.
A way to prevent these unfortunate side effects is for financial service providers to avoid single prescriptions and actively work towards enabling multiple avenues for credit, so that people like Justin can have several shots at getting the credit they need. Providers should recognize that they might never get close enough to poor customers living in marginalized communities to fully understand their evolving circumstances and options.
So in addition to seeking ways of collecting more data on prospective borrowers with which to make individual credit decisions, lenders should also seek ways to build more trusted relationships with local players in each community, who they can count on to make credit recommendations and help channel credit within their network of friends, customers, savings circles, and business associates. Justin´s credit need not come directly from a bank, it could come from a local store that understands the true nature of his troubles, or a neighbor who knows how he´s turned himself around.
In a recent paper, we develop this theme by exploring three different Pathways to Smarter Financial Inclusion: by serving poor people directly, reaching poor people indirectly through the businesses within their communities where they work and buy things, or using social networks as (informal) distribution channels. Note that all three pathways rely heavily on clever analytics, but the objective of each is subtly different: the first draws credit inferences from the little data that is specifically available on poor customers, the second creates sufficient business intelligence and data flow to be able to underwrite local traders´ and entrepreneurs´ credit decisions, and the third creates incentive structures for peer screening and monitoring.
Finance will reduce people´s sense of vulnerability only if it creates a hierarchy of options in people´s minds. It´s not necessarily the case that people want more credit, they just want more options. By moving beyond traditional methods of collecting and interpreting borrower data, financial service providers can help provide those options to people who are often excluded.
[From Brookings Institution´s Tech Tank blog, 2 December 2014 (with David Porteous)]
It’s easy to imagine a future in a decade or less when most people will have a smartphone. In our recent paper Pathways to Smarter Digital Financial Inclusion, we explore the benefits of extending financial services to the mass of lower-income people in developing countries who are currently dubious of the value that financial services can bring to them, distrustful of formal financial institutions, or uncomfortable with the treatment they expect to receive.
The report analyzes six inherent characteristics of smartphones that have the potential to change market dynamics relative to the status quo of simple mobile phones and cards.
1. The graphical
Service Provider Changes:
4. Greater freedom
to program services without requiring the acquiescence or active participation
of the telco.
Taken together, these changes may lower the costs of designing for lower-income people dramatically, and the designs ought to take advantage of continuous feedback from users. This should give low-end customers a stronger sense of choice over the services that are relevant to them, and voice over how they wish to be served and treated.
Traditionally poor people have been invisible to service providers because so little was known about their preferences that it was not possible build a service proposition or business case around them. The paper describes three pathways that will allow providers to design services on smartphones that will enable an increasingly granular understanding of their customers. Each of the three pathways offers providers a different approach to discover what they need to know about prospective customers in order to begin engaging with them.
Pathway One: Through Big Data
Providers will piece together information on potential low-income customers directly, by assembling available data from disparate sources (e.g. history of airtime top-ups and bill payment, activity on online social networks, neighborhood or village-level socio-demographic data, etc.) and by accelerating data acquisition cycles (e.g. inferring behavior from granting of small loans in rapid succession, administering selected psychometric questions, or conducting A/B tests with special offers). There is a growing number of data analytics companies that are applying big data in this way to benefit the poor.
Pathway Two: Through local Businesses
Smartphones will have a special impact on micro and small enterprises, which will see increasing business benefits from recording and transacting more of their business digitally. As their business data becomes more visible to financial institutions, local firms will increasingly channel financial services, and particularly credit, to their customers, employees, and suppliers. Financial institutions will backstop their credit, which in effect turns smaller businesses into front-line distribution partners into local communities.
Pathway Three: Through Socio-Financial Networks
Firms view individuals primarily as managers of a web of socio-financial relationships that may or may not allow them access to formal financial services. Beyond providing loans to “creditworthy” people, financial institutions can provide transactional engines, similar to the crowdfunding platforms that enable all people to locate potential funding sources within their existing social networks. A provider equipped with appropriate network analysis tools could then promote rather than displace people´s own funding relationships and activities. This would provide financial service firms valuable insight into how people manage their financial needs.
The pathways are intended as an exploration of how smartphones could support the development of a healthier and more inclusive digital financial service ecosystem, by addressing the two critical deficiencies of the current mass-market digital finance systems. Smartphones could enable stronger customer value propositions, leading to much higher levels of customer engagement, leading to more revelation of customer data and more robust business cases for the providers involved. Mobile technology could also lead to a broader diversity of players coming into the space, each playing to their specific interests and contributing their specific set of skills, but together delivering customer value through the right combination of collaboration and competition.
[From NextBillion blog, 13 November 2014]
Consider for a moment three hypothetical missed business opportunities.
You are an experienced, confident entrepreneur with a cool new idea for an electronic financial product that you are sure will catch the interest of the mass of poor people who are still unconvinced about banking. You get an e-money license from the central bank, and that gives you license to form your own cash in/out agent network. But you see yourself as a digital venture, and as a start-up you know you are too small to develop your very own dense, reliable network of stores. The other licensed players out there will not let you use theirs. Why should they? You are a competitor. Sure, you could sign up the same stores in their networks as your own agents, which would make it easier - but you want to spend your time creating great digital experiences, not cajoling shopkeepers. You figure it´s just too hard, so you don´t enter the market.
You come from the fast-moving consumer goods (FMCG) industry, and you have years of experience building retail channels. You see an opportunity in managing the cash in/out requirements for all bank and mobile money issuers. You are thinking of creating a shared agent network; surely those companies will all jump at the opportunity to outsource that irksome function to you? You have no trouble signing up all the desperate, small players who know they can´t make it work on their own. You also sign up some bigger banks that don't really have much interest in financial inclusion anyway, but want to report large agent numbers because it makes them look good. But the big fish — those that can bring the transaction volume that you need — avoid you like the plague. After all, your value proposition to them is to dilute their competitive advantage. You can´t get over the irony that mobile operators — native corporate children of the digital age — insist on competing on the basis of who has the biggest physical cash network. You realize it´ll take years of going up the issuer food chain, to convince the bigger guys that they need you more than you need them. So you give up and go back to distributing soft drinks.
You are a local entrepreneurial shopkeeper, and you see that you can extend your product range virtually and become the interface for your clients to do all their cashing in and cashing out. But then you learn that you need to sign a contract with each bank and mobile money issuer in sight. After you sign up some, others don’t want to give you a contract at all, because you are tainted as being with one of their dreaded competitors. Now you can no longer aim to serve all your customers, which doesn't sound like good business to you. And those that do give you a contract expect you to have a separate pool of money dedicated to them. Each wants you to put all their signage on your storefront. Each has a different system that your employees need to learn. Each sends someone to supervise you; who are these nosy busybodies? This feels crazy: You want one system that helps you serve all customers from one inventory. Forget it, you shelve these plans.
Given these stories — all of which are based on very real impediments facing would-be entrepreneurs around the world — are you surprised that most agent networks are struggling, except perhaps for those of the biggest telcos and banks in the land? And the consequences of these struggles reverberate far beyond the agent networks themselves. In fact, there isn't a competitive supply of digital financial services because few find a way to overcome the tough realities of cash distribution.
It does not need to be like this. Just one regulatory change — creating a new license category for cash in/cash out agent network managers who are authorized to operate independently of account issuers — would go a long way to eliminating the barriers to entry, operational pain and duplication of efforts that we suffer from today. (Read this paper for a fuller articulation of this proposal.)
Would this change give a second chance to our three hypothetical entrepreneurs? Consider these alternate scenarios:
The entrepreneurial FMCG guy gets this license from the central bank, then starts facilitating cash in/out for any and all banks and mobile money operators simply by opening a corporate customer account with each. Once he´s got his own money in their system and has access to their mobile or online banking interface, he can then exchange it for his cash. Now the situation is flipped: he chooses whom he wishes to do cash in/out for, and the banks and mobile money issuers have no say in the matter. (Just like if I have money in a bank account, the bank can´t tell me how I can and cannot use it.)
The entrepreneurial FMCG guy then approaches the entrepreneurial shopkeeper. Love at first sight: with one contract and one system, the shopkeeper can serve all of his clients. There’s no need to seek out anyone else.
Then the entrepreneurial digital financial product guy comes along with his cool product idea and convinces the (now licensed) FMCG guy to open an account with him; he might even give the FMCG guy a small monetary incentive for the trouble. Now he can boast the same agent coverage as everyone else. Overnight. He can finally start proving that his digital product idea is really as good as he thinks.
One regulatory change, three dramatically changed stories. Note that the nature and content of agent regulations (on publicizing a customer care line, pricing transparency, documentation requirements on retail outlets, etc.) need not change at all; the only thing that would change is the party that is responsible for them. All we´ve done is to shift the locus of some of the regulatory provisions from licensed issuers to the new category of licensed agent network managers.
That will bring branded competition to agent networks, and therefore, to digital services as well – a big payoff for such a simple change.
[From MFW4A´s Africa Finance Forum blog, 10 November 2014]
In a panel in a recent IFC/MasterCard Foundation conference in Johannesburg, Mark Flaming of MicrCred reminded us that there is a tension running deep in all regulatory discussions of digital financial services (DFS) for financial inclusion, and that is between the banking and payments traditions. These are differentiated regulatory pillars that are deeply ingrained institutionally as separate departments within every central bank, and as separate committees within the Basel structure at the top of the global regulatory food chain. The two traditions are increasingly encoded legally, as more developing countries are passing payments systems laws distinct from banking laws.
Payment system departments within central banks have an instinctive understanding of network effects, so they tend to be friendly to an inclusion agenda that promises to connect more people to payment networks. Also, their general aspiration is to increase the share of transactions that happen in real time and reduce credit and counterparty risk, so digital financial inclusion platforms are in fact supportive of their system stability objective.
Banking supervision departments, on the other hand, tend to take a much more cautious approach. They tend to worry much more about financial depth relative to the volume of economic activity rather than the size of the population. Their supervisory resources are much more overworked given the inherently more complex and untransparent business of banking, and tend to look at technology, service and business model innovation with more suspicion, as things that could potentially get out of hand. The global financial crisis has of course given them ample evidence to support this instinct. They are more focused on protecting what is (risks) than on pushing the frontiers (opportunities).
So which side of the regulatory house should own, or at least take the lead on, financial inclusion for the masses in developing countries? Things have moved fastest in countries that have given it to the payments side, which tends to be more in tune with infrastructure-light digital service platforms and more comfortable dealing with a broader range of players. Under a new type of e-money issuer (EMI) license, they are letting non-banks (and in particular mobile operators, but also electronic top-up specialists and independent retailers), offer basic transactional services to those for whom traditional banking services are too costly, inconvenient, or simply unavailable.
But this has been the problem: payments people very reasonably worry that this foray into proto-banking risks tipping their side down a regulatory slippery slope that may lead to the kind of burdensome prudential and consumer protection regulation that mires the banking side. One way to avoid this has been to sharpen the differences between electronic money and banking services - so that putting money in an electronic money account is made to feel very different to putting money in an electronic bank account.
Accordingly, EMI licenses in many countries carry tough restrictions such as precluding payment of interest on saved balances, imposing lower account caps, banning their marketing as savings accounts or using the term banking at all, banning the bundling of credit offers even if they are funded externally to the EMI, and excluding them from deposit insurance. But this just seems like an overly limited banking option for the poor: financial inclusion ought to be more than payments.
This sharp distinction between EMIs and banks has also introduced regulatory arbitrage opportunities between banks and EMIs, insofar as the payments and banking supervision departments set different standards for service functions common to both, such as requirements for account opening, e-channel security, and contracting of retail stores as cash in/out agents. In some countries, this has made it easier for mobile operators rather than banks to offer basic financial services to the (traditionally excluded) mass market.
I argue in a new paper that the next round of regulatory reforms for financial inclusion needs to address both these issues. By neglecting savings, the current practice does not serve a full enough vision of financial inclusion.
Firstly, EMIs licensed under payments system frameworks need to be unencumbered from unjustified restrictions. In particular, they should be able to offer savings services on the same basis that banks do. For the essence of banking is not the mere act of taking deposits (which is easy to supervise), but rather the reinvestment of those funds in a way that entails credit and liquidity risk (which is not so easy to supervise). Accordingly, EMIs serving the poor should be reinterpreted as narrow banks - institutions that take deposits from the public and manage customer accounts on the same terms as banks do, but that do not intermediate the corresponding funds. Because narrow banks don´t themselves place bets with depositors´ money, they should remain firmly in the payments pillar.
Secondly, regulation should aim not only to introduce new types of competitors, but also to create a more level playing field between players licensed under banking and payments pillars when they perform similar functions in similar fashion. Banking regulators need to be much more open to adopting the kinds of regulatory practices that payments regulators employ routinely when real-time technology platforms are used in a way that minimizes credit and counterparty risks. A key element here is cash in-cash out (CICO): it should not be any more difficult for banks to engage third-party CICO outlets than it is for EMIs, provided that all transactions happen securely on the bank´s technology platform in real time.
[From Center for Financial Inclusion blog, 29 October 2014]
Have you noticed how narrow the interventions of the chorus of financial inclusion supporters have become? Academic researchers are immersed in proving whether an SMS message sent at the right time can push people to repay their loans more promptly (a.k.a. nudges), or whether someone with more savings is likely to be happier and more empowered in some way (a.k.a. impact evaluations). NGOs fund numerous papers and conferences to promote the idea of seeking early and frequent customer feedback in product design (a.k.a. human-centered design), or of looking into customer data for some clue as to what interests them and how they behave (a.k.a. big data). Donors set up round after round of tenders with subsidized funds to spur fully-grown banks and telcos to try out a new product feature (a.k.a. challenge grants), or to prop up the marketing and distribution wherewithal of selected players (a.k.a. capacity building).
All this buzz surely is positive and the things that come out of these activities may well be part of the answer to the financial inclusion challenge. But this begs the larger question: why aren´t these rather obvious and incremental things done by interested market participants themselves? Why don´t they already experiment with customer communication modes and new product features? Why don´t they eagerly seek out impact data that can drive effective marketing and PR, or more routinely seek customer feedback to improve their products and operations? Why don´t they systematically leverage customer insight as a core asset, and why do they underinvest in novel customer promotion techniques?
In other words, why is there such an inherent innovation deficit within the very commercial ventures that we think are going to drive financial inclusion forward? Do market players really need this very granular level of handholding to getwhat academics, NGOs, and donors so clearly believe in?
To put it more bluntly: do we really need to continue subsidizing sustaining innovation like this? Or is the problem, rather, that there isn´t enough of a competitive push to drive them to want to innovate as a key source of market advantage? Would more competition for and within the market drive the kinds of innovations that are being promoted from the sidelines?
I think the latter. Consider the current innovation frenzy in digital financial services in the US. Google, Amazon, and Apple all want to join early mover PayPal in getting inside or becoming people´s electronic wallets. Facebook and smaller start-ups like Dwolla and Venmo all want to revolutionize how money is sent online. Players like Smartypig, Simple, and Moven want to reinvent how you deal with the money sitting in your bank account. Established players like MasterCard and new ones like Square want to change how you pay for goods at the store. Not to mention, of course, the slew of bitcoin start-ups.
Now ask yourself: why are none of these players vying for the blue space that is the billions of people who are excluded? Aren´t these companies the ones who are best placed, with their high-volume, low-cost digital platforms and viral marketing savvy, to radically transform the economics of financial service delivery? Why isn´t the chorus of financial inclusion supporters simply putting their desire for innovation at the feet of these corporate digital natives?
And let me tell you, they are right not to do so. That´s because there are three things none of these digital players want to deal with – and never will. They do not want to get a banking license that embroils them in onerous regulation. They do not want to conduct primary identity checks on their customers (Know Your Customer, or KYC), which require physical customer contact. And they do not want to touch their customers´ cash. That´s why all digital financial players, exciting as they may seem when you look at their wares online, sit parasitically on top of banks. You will not have access to their services if you do not already have a bank account: to deal with regulatory aspects, to conduct primary KYC, and to do cash in/out through them.
It follows that these digital players will not lead the charge on financial inclusion in developing countries. At most they will wait tactically in the sidelines and pick up customers as they trickle into the formal financial system. But most won´t even do that: these businesses´ DNA is all about scale and network effects, so if they can´t go for size then they may not go there at all.
Unless. Unless we give them an alternative path to delegate, or even avoid, these three things that they don´t want to do. A way into developing markets that does not make them entirely dependent on banks to first open up the space for them. Here´s how. First, give these players the opportunity to get a more lenient e-money license which does not constrain them in what services they can offer customers, but bars them from loaning out or otherwise speculating with (i.e. intermediating) customers´ funds. Second, allow them to offer an entry-level account that requires noidentity checks; cap usage of that appropriately, so that more onerous KYC procedures kick in only when customers are ready to give the account more serious use. And third, delink cash in/out networks from specific account issuers, so that a breed of independent cash in/out network managers emerge with the vocation to serve all issuers, all stores, and all customers. All they should be required to have is a customer account, but not an agency contract, with each issuer. (If you are thinking that this is the standard branchless banking regulatory prescription, think again, or, better yet, read this.)
You will have noticed that these points are all about regulation. Regulation holds the key to creating a competitive environment that is more welcoming of innovative digital players. In the end, the chorus of financial inclusion supporters are getting involved in the supply of innovation simply because they want to avoid the morass that is regulatory reform. But if they truly want to make an impact on financial inclusion, they should go back to focusing on basic market enablement rather than merely filling innovation gaps.
[From MicroSave´s Financial Inclusion in Action blog, 15 October 2014]
We do most of our work in a historical vacuum. We tend to think of today's problems and opportunities as unique. That's a natural bias in an age imbued with a sense of inexorable progress reliant on technological solutions. But if we lift our gaze over historical time, we find numerous references to issues and debates that are not unlike those prevailing today. There's nothing like historical perspective to temper one's excitement about the latest idea or trend. Maybe that's why we shy away from probing too deeply in our history books.
Let me share three things about the past that I've recently become aware of that relate to contemporary discussions of financial inclusion.
Big history: G2P payments and the origin of coinage
In his sweeping historical account of the development of credit and money systems, David Graeber, author of Debt: The First 5000 Years, makes the claim that it was governments, not markets and the spirit of enterprise they embodied, who had the burning need that led to the invention of coinage. Markets could function just fine with credit arrangements when people bought stuff from one other, with trusted parties clearing (or discounting) debts between people from different localities who didn't know each other and were not likely to meet again. Hence the observation, which I wrote about in this blog a year ago, that money has always been largely virtual.
But governments of the time had a specific need for a readily exchangeable, portable, tokenized form of value that could be used for mass micropayments: for the victualing and quartering of troops as they marched and spread across the territory. Governments then stepped up taxation as a means of getting those coins back from the people, so that they could be recycled. So markets worked on ledgers, but armies needed cash. Of course, once coins became widespread, markets readily adopted them, but the vector for mass adoption lay elsewhere.
I am struck by the similarity with the situation today. The new burning micropayment need of most developing countries is the distribution of cash-based social welfare payments to a rising share of the population. And indeed we see that in many countries –and for many donors— it is the need to make G2P payments that is driving the agenda around digitizing money, for finding something that is Better Than Cash. These schemes may help many needy people, but at its core it is about meeting a pressing government need.
Family financial histories
We often go out searching for financial tidbits in poor people’s lives, but have you wondered about the financial history of your own family? Try asking your parents and grandparents the kinds of questions we so mechanically ask total strangers in foreign lands.
I asked my parents, who grew up in an impoverished, conservative, isolated, economically mis-managed, post-civil war Spain. They were the first in their families to go to college. I learned that their parents didn't have bank accounts, but neither did most everyone else they dealt with. When my parents were growing up, cash was hidden around the house, and some of it was spread over several envelopes. What if they needed money? My father made the gesture of a finger slipping in and out of a ring: my grandmother's wedding ring doing regular financial duty at the pawnshop. Both my parents agreed that in case of need within their respective families, the main option was to scramble for more work. It's almost like their parents were purposely holding back from doing more work regularly in order to leave some room for extra income in case of need.
All this may sound familiar. But what really struck me was how uncomprehendingly my parents looked at me when I insisted on knowing how their own parents managed without a bank account. It just didn't seem that important to them, at the time. My parents both became doctors, and learned to avail themselves of the convenience of modern banking. But they are clear in their minds that the account came with their economic and professional success, not the other way around.
Do you know your family's financial history? When and how did a bank account first enter your family's life, and how momentous did that seem to them?
150 years of financial diaries
It is said that writing evolved from the need to record debts. We tend to look at money matters like they hold an important key to understanding broader personal and societal matters, which may be why we have such fascination for understanding how others manage their money.
It should be no surprise, then, that there is a long tradition of conducting financial diaries. In her study spanning the period 1870-1930 in the United States, Viviana Zelizer discovered numerous instances of “household-budget studies” that “richly documented how the working class and lower-middle class spent their money,” at a time when the consumer society was being established. Even our research methods are not so new.
[From Bill & Melinda Gates Foundation´s Impatient Optimists blog, 12 August 2014]
Digital finance encompasses the notions of: (i) electronifying poor people´s monetary holdings; (ii) creating end-to-end cashless payment ecosystems reaching down to the base of the pyramid;(iii) pushing financial transactions outside of costly bank branches and into normal retail shops; and (iv) inducing a shift from riskier, traditional, informal financial practices into structured financial services (savings, credit, insurance) from formal, regulated institutions.
That´s a tough combo.
If I were grading the performance of the developing world as a whole on these four dimensions, I´d only give a comfortable passing score on (iii). Of course it´s still early days, countries have been on this agenda for anywhere between 0-10 years, and it will no doubt take another decade or two before we see substantial inroads. I do think there is an inevitability about this journey that will ultimately carry us through. But the hype about all the progress on the ground is, in my view, exaggerated.
Still, are the efforts well directed? I am certainly impressed with the number of providers that are having a go at it, though I´d like to see more banks and third parties joining the telcos in this club. But the main worry I have is the very limited extent of innovation and differentiation that I see as I go from country to country, and from provider to provider. It is hard to imagine, in these early days, that anyone has fully figured out the magic formula, and yet we seem to be trying very few formulas.
Over the last year, I have been looking at the pace and constraints on innovation in digital finance, under research I have conducted under a Gates Foundation-funded Fellowship at the Saïd Business School at the University of Oxford. In a sequence of four papers, I have looked at it from different angles:
· Client view. The paper “Digitizing the Kaleidoscope of Informal Financial Practices” contrasts the psychological and cultural richness of informal savings mechanisms with the simpler, more rigid and yet less intuitive format of digital savings products. The paper argues that financial inclusion should not imply a rejection of informal financial practices but a synthesis of the informal and the digital.
· Provider view. The paper “Product Innovations on Mobile Money” (co-authored with former BMGF colleague Mireya Almazán) contains a thorough review of the state of product development and innovation on mobile money platforms. We find that the range of product categories such platforms support is still rather narrow, but the specific ways in which services are defined and packaged do vary significantly across operators and markets.
· Technology view. The paper “Why You Should Care about Bitcoin – Even if you don´t Believe in it” explores what a truly innovation-friendly electronic currency system and payments infrastructure might look like. A software-protected currency operating with a public ledger system –the key technology elements behind bitcoin— has the potential for supporting the development of more open, contestable and interconnected ecosystems for the delivery of payment and financial services, much like the internet did for the delivery of communication and content services.
· Regulatory view. The paper “Shifting Branchless Banking Regulation from Enabling to Fostering Competition” argues that regulations on e-money issuers, retail agents and account opening need to be recast so as to reduce the cost of entry and give much more scope for service and business model innovation. In addition, there is a growing need for policymakers to ensure there is a level playing field across all players, and that mobile operators do not exploit their dominance in the mobile communications market to gain advantage in the new market for mobile financial services.
My main take-out from this work is that there is still much we need to learn and many approaches we need to experiment with before technology-based approaches can become a reliable tool for financial inclusion across the developing world.
[From World Bank´s All About Finance blog, 8 August 2014]
Branchless banking and mobile solutions in developing countries tend to be dominated by very few large (mostly telco) players, focus narrowly on the payment function of money that calls for a national footprint, elicit relatively infrequent usage from the majority of customers, and exhibit low levels of service innovation. There are few examples globally of what I call an intensive model: smaller players making the business economics work by driving much greater usage from a much smaller customer base.
Tackling financial inclusion — that is, making financial services truly a mass-market offering — will require more, and more diverse, players contributing variously their resources, inventiveness and goodwill. We need more players jumping in: to create more competitive tensions and force more service and business model differentiation, but also because in most markets the usual path to scale is through specialization.
In a recent paper, I argue that the prevailing regulatory “best practices” in branchless banking and mobile money focus on enabling participation in the market but are not sufficiently strong in fostering competition. There are two sides to this.
First, regulators can reduce the cost of entry and give much more flexibility for new entrants wishing to contest the market, while still entirely protecting the integrity and safety of the system. There are usually strong barriers to entry embedded in the following types of regulations:
1. Agent regulations, and the need to secure a retail cash in/out footprint. The obligation on financial service providers to appoint retail outlets as agents has the perverse effect of fragmenting the retail base across a multiplicity of providers, each seeking locational advantages, and forces each financial service provider to assume daunting operational and legal responsibilities. A more scalable and entry-friendly approach would for the financial authority to license (and supervise) cash in/out networks as independent entities, giving them the freedom to serve any and all financial service providers they wish merely by maintaining customer accounts with each. When transactions occur on a real-time, prepaid basis, financial risks are few; regulation of cash in/out networks would therefore major on consumer protection aspects. Shifting the contractual basis between issuers and cash in/out networks would naturally lead to broadly shared and interconnected agent networks.
2. E-money licenses, and the need to operate under a ´sub-banking´ license. Many countries have opened up the possibility of providers getting an e-money license, but this license is generally conceived as an inferior form of banking. It is common for e-money license terms to preclude paying of interest on saved balances, impose lower account caps, ban their marketing as savings accounts or using the term banking at all, and exclude them from deposit insurance. What is required is a license that does not constitute an alternative to banking, but an alternative form of banking – one that entails fewer risks. E-money licenses ought to be conceived as narrow banking: it is like a normal bank on the liability side of its balance sheet (and hence not subjected to the limitations enumerated previously), but is heavily restricted on the asset side (hence presenting much lower risk).
Second, there is a growing need for policymakers to ensure there is a level playing field across all players, whether they are large or small, whether they have one type of license or another, and whether they are banks, telcos or any other type of players. The following issues need to be placed more squarely in the center of the emerging regulatory framework for digital financial services:
3. Preventing regulatory arbitrage. Regulations must not provide any unjustified regulatory advantage to one type of license holder over any other, and in particular should not be more burdensome for banks rather non-banks (including telcos). License terms can be different only insofar as different types of license holders are exposed to different types of risks, based on the activities they are allowed to carry out. Thus, it is legitimate for banks to have more intermediation freedom than e-money issuers, in return for which they are subjected to higher capital requirements and more intrusive prudential supervision. But it is not reasonable for banks and e-money issuers to be subjected to different regulations for agent banking or account opening, which are common functions to both types of licensees.
4. Preventing anti-competitive practices by dominant players. Network-based markets, of which electronic payments is one, are characterized by economies of scale and network effects, which confer strong advantages to the larger players. Regulators must therefore take steps to prevent larger players from exploiting their scale advantage to lock out smaller competitors, by driving towards interconnection of platforms (interoperability) and precluding pricing below cost (anti-dumping).
5. Preventing mobile operators´ abuse of essential service elements under their exclusive control. Mobile operators´ participation in retail payments presents competitive challenges which banking and telecoms operators will need to monitor closely and address jointly. The problem is that mobile operators are both component suppliers and direct competitors to financial institutions wanting to offer mobile financial services. There is a risk that mobile operators transfer market power from their core telecoms market to the emerging retail mobile payments market, in such a way as to effectively shut banks out of mobile payments. Competition policy needs to be vigorously applied to ensure that mobile operators do not use their market power in the communications market and their control over the telecoms numbering range to gain unfair control over financial service providers who must use the telecoms services of mobile operators.
[From Center for Financial Inclusionblog, 6 August 2014]
I guess it happens in all human endeavors; we sometimes get carried away wishing things were the way we think they ought to be. Let me provide three cautionary observations relating to financial inclusion: about how we measure it, how we talk about it, and how we assess it. The point is not to dampen enthusiasm about the possibilities, but to reflect on our progress in a more realistic way.
Industry Showcases and the Numbers Game
Through numerous industry conferences and blogs, certain players get put up as shining examples for the industry to follow. M-Shwari is perhaps the latest one, I guess because it delivers large customer numbers to an industry that is still largely focused on coverage rather than usage, and it represents the kind of telco-bank partnership that many have been fantasizing about.
M-Shwari may indeed be every bit the financial inclusion success that it is made out to be, but how is one supposed to judge that, based on the sparse numbers that have been released? This is pretty much all we know: as of March 2014, 6.8 million registered customers, of which 3.6 million were active, collectively had $46 million in deposits and $14 million in loans outstanding; 15 percent of loan requests were approved, and 2.7 percent of loans were non-performing. Now, is the savings balance total the result of each of the 3.6 million active customers squirreling away $13 for a rainy (more like drizzly) day ($46m ÷ 3.6m = $13), or is it more likely that most of the savings comes from fewer than 100,000 busy traders who are saving $500 ($46m ÷ $500 = 92,000) in order to create more transactional head-room for their linked M-Pesa account? We just don´t know. But then, how can we have an opinion on M-Shwari’s efficacy as a financial exclusion buster?
We must refrain from unduly extolling cases on which we have not been invited to know enough. We need to look beyond average balances, which are typically highly skewed by large balances at the very top of the distribution. Donors, policymakers, and pundits must start asking for customer distributions before parading any savings effort as a success.
Digitization of Payments and the Journey to Cash-Lite
What do we mean when we talk about digitization of G2P payments? Most government payments have for a long time been digitized, at least at source. No ministry holds a huge cash stash to pay pensions and welfare benefits. Now the trend is to pay these directly into beneficiaries’ digital accounts, rather than to intermediary entities for onward distribution of the cash. But when beneficiaries are paid digitally, the practice pretty much universally is for them to withdraw the money in cash immediately and in full at local shops acting as agents, who have the thankless task of procuring the cash. So, in what sense has the payment been digitized? The same amount of cash is still involved, it just got to beneficiaries through a different channel. All we’ve done is outsource last mile cash distribution to retail outlets, via a financial service provider.
This is not to say there is no net benefit: account-based G2P payments are much less prone to corruption, and bank agents may be closer to where beneficiaries live than the old government cash distribution points. But people’s money is for the most part no more electronic than it was before. And by the way, this is true as much for P2P as for G2P payments, and in Kenya as much as everywhere else.
Moreover, because most electronic accounts are largely empty, users do not have a natural preference for paying electronically at the corner store, so local electronic acceptance by local merchants does not take off. Contrary to frequent commentary, digitization of payments is therefore not leading to a cash-lite world. We are confusing the digitization of payments (how money moves around) with the digitization of money (how money is held).
Impact Evaluation and Silver Bullets
Few would argue that there are any silver bullets—understood as simple solutions to complicated problems—in development. We know that progress occurs from the interplay of various forces and interventions—access to education, information, markets, finance, infrastructure, legal and physical security, etc.—and that none of these individually stands a chance to transform lives. The impacts of finance happen mostly through indirect channels, through a process not unlike multiple particle collisions. So when we insist on measuring the impact of financial inclusion programs by carefully isolating single treatments/collisions, aren’t we secretly wishing to find a silver bullet?
While I understand intellectually the need to conduct impact evaluation, how realistic is it to expect to find sustained, systematic impact from narrowly defined and precisely controlled financial interventions? How much mileage will we get from building ever-more precise Hadron Supercolliders in the social sciences?
I’m just sayin’…