Mobile money in 2006 and 2016

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Editor’s Note: Michael Klein is the former Vice President of Financial and Private Sector Development of the World Bank Group and is currently Visiting Professor at Harvard and Johns Hopkins University.

Nairobi 2006. Making Finance Work for Africa is the topic. Bankers, officials of monetary authorities, regulators, representatives of the IMF and multilateral development banks crowded in the conference room of the Serena hotel to launch the new Making Finance Work for Africa report. When I arrived at the airport, it was hard not to notice the omnipresent Safaricom ads: “Roam with the largest herd”. Luckily, I had chosen to present at the conference on the potential for mobile money, branchless banking and the like. Just a few months later in March 2007 Safaricom launched its M-PESA service. Today—less than 4 years later—M-PESA helps some 60 per cent of all adult Kenyans with payment services and is all the rage in the world of microfinance, in Kenya and beyond.

M-PESA reaches all over Kenya. 23,000 shops, often within just a few meters from each other, proliferate in slums and villages. Changing money at these cash merchants is pretty much like buying any other product in a shop; consumers face no or few lines, take advantage of opening hours from early till late, and can find cash merchants close to places of business or residence. The benefits are numerous: life is easier and safer; money is harder to steal or lose; waiting at the bank is over. Mobile phones make it possible. The herd of roamers comprises most adults in Kenya. And they have voted with their feet and money: payment services are what they want from financial inclusion.

Clever business people with prodding from the UK’s Department for International Development made it happen. The Central Bank of Kenya allowed it to happen. Some banks were and are furious. Competition in the small payment business by M-PESA hurts banks like Equity, which is a local champion of micro-finance and has a significant retail payment business of its own. Yet, Kenya’s Central Bank waved the new approach through, and with good reason. It helped chart a new course for regulation of mobile retail payments. In the process, M-PESA challenges the way we think about banking regulation.  The Central Bank of Kenya may well have helped chart the basic course for many other mobile money schemes in the world.

M-PESA’s business model makes it clear: one needs to “unbundle” the various functions a bank typically performs and look at each in turn. Suitable regulatory approaches will differ by function, with each function potentially performed by a different entity. What basic functions are involved in banking? Exchange of types of money, storing money, transferring money and investing money.

The cash merchants function as money changers. Suppose a worker in Nairobi wants to send money to his wife in a village. The worker goes to a cash merchant and gives the merchant paper money  The merchant, in return, gives the worker book-entry money (BEM) by instructing M-PESA via mobile phone to transfer BEM from the merchant’s account to that of the worker. Exchanging one form of money for another is like exchanging bills for coins. There’s no need for prudential regulation—otherwise all machines that spit out coins for bills should be regulated too. The cash merchants are colloquially called “agents”, but they are not agents in the sense of a banking agent that needs regulation. They are money changers. In principle, anybody with an M-PESA account can perform the exchange function. This is a contestable business with options for free entry.

M-PESA provides two functions. It stores money in the form of BEM and it transfers it. People storing money with M-PESA are rewarded in the same way as if they had stored the money in a safe-deposit box. They get no interest and the nominal value of the money is preserved. When the worker has BEM in his M-PESA account, he can instruct M-PESA via mobile phone to put the money into the account of his wife. The system requires reliability, integrity. That means standard protections from commercial law and maybe some special consumer protection to help insure the system is safe. No prudential regulation with capital requirements is required. We can call the money in M-PESA accounts “deposits”. As such they are deposits in the sense that money in a safe-deposit box is a deposit—but not in the sense of banking regulation. And by the way, the phone is not an “e-wallet” or “e-purse”. That may be exciting terminology, but the money is stored in the electronic “books” of M-PESA. The phone serves to relay instructions and messages. When the phone is lost, the money is still there—not like a wallet is lost with the bills inside.

So far, this whole process happens entirely outside the banking system. However, M-PESA and the Central Bank recently came to an understanding that the net cash deposited with M-PESA at any time should be deposited in a bank (in fact, in two banks to diversify risk). In turn, the banks can invest the deposits, but this introduces risk because of the maturity mismatches between deposits and loans. The net cash held with M-PESA is as safe as any deposit in a bank that is supervised by the Central Bank. Consequently, there’s no need to subject M-PESA to additional supervision beyond specifying what kind of deposits in which banks are acceptable to the regulator. In this model, M-PESA acts as an aggregator or conduit for bank deposits. What strictly needs regulation is not “deposit-taking” institutions, but “deposit-investing” ones, i.e. the banks, not M-PESA. The fundamental consequence for regulation is to think in terms of “regulation by type of service”, not “regulation by institutional label” (e.g. a bank).

New technologies allow old business models to be reconfigured. These technologies change both the marketplace and the appropriate regulations for this reconfigured marketplace. And continual change has proven to be a fact of life in information and communication technologies. Already, a small cluster of software developers have sprung up in Kenya who are testing new ways of creating platforms for storing and moving money. Competing telecom companies are testing their own business models.

M-PESA did not exist when I attended the Nairobi conference less than five years ago. Equity Bank was all the rage in microfinance circles, with its unprecedented outreach to the common people. At the time, the whisper in the corridor was: Isn’t Equity Bank growing too fast? Just wait to see if the portfolio is really sound. Shouldn’t the regulators be more cautious in the face of such growth and with the money of so many depending on it? Today, Equity Bank has matured into Kenya’s largest bank. And the whisper now is: Isn’t M-PESA too big? Is the money of all those poor people really safe? Do payment services really add up to financial inclusion?

I look forward to returning to Kenya in 2016 for the 10th anniversary of Making Finance Work for Africa. Let’s see what company they’re whispering about in the corridors then.


Michael Klein

Professor, Frankfurt School of Finance and Management

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