This post is part of our Closing the Gap: Financial Inclusion blog series, which shares the views of selected experts and practitioners on different financial inclusion topics.
The internet did not grow by having established old media companies jumping at the fantastic new opportunities offered by the new medium. For a long time they resisted giving their customers the convenience of immediate online access to their products; they resisted letting their customers tinker with the format (the newspaper, the CD, the TV series) when all they wanted was a component of it (an article, a song, a sketch); they were loathe to trade off lower margins for higher volumes. And when they finally started offering their content digitally, they were more interested in using the new medium to restrict their customers’ options than to enhance their customers’ sense of control: whereas before I could loan a book to a friend under a broad fair use clause, now I can’t easily share my e-book without being made to feel like an e-criminal.
Media companies were too focused on the risk of losing what they had: certain revenue streams and a certain relationship with their customers. It took industry outsiders (Apple iTunes, Amazon) to figure out a commercial path to bring the old players into the new online world.
Why should it be any different with banking for the poor? Why should we expect established banks to see opportunity where they have never seen it before? Why should we expect them to want to disrupt their comfortable business model, attractive margins and well-worn practices – which are what leads them to ignore the majority of the population in developing countries?
Financial inclusion will only be accelerated if there is an element of disruption thrown into banking. That’s what M-PESA in Kenya represents: someone coming from left-field and doing what banks didn’t think was commercially possible. M-PESA is an excellent provocation to the sector, in the same way that Apple’s iTunes was for music. (Incidentally, on the eve of its fifth anniversary M-PESA got an excellent book-length biography which, in the spirit of this post, is so far only available on Kindle at the remarkably low price of $3.54 – get it here.)
Media houses eventually came around to the online world, once it came down to sink or swim. Unfortunately, banks will take longer to embrace online and mobile technologies to dramatically expand their market beyond the corporate and the affluent because they are strongly protected by regulation. Where there are strong regulatory barriers to entry, innovation and disruption will have to come from within. What are the precedents for that?
Regulators need to get comfortable with rapid change. Change doesn’t necessarily mean a free-for-all, it means creating a more nuanced regulatory framework that introduces new types of licenses with regulations commensurate with the risks involved. No one I know is suggesting a less safe, much less an unregulated, banking system for the poor. But you don’t need to put the same padlock on your garden shed as you’d put on your house – that’s the principle of proportionality.
So what kinds of new players does regulation need to enable before we can hope to see an explosion in branchless and mobile banking for the poor? A key one is electronic account issuers that take money from the public but do not themselves intermediate those funds. What they do is invest every last dollar they get from their customers in very safe and liquid assets, like bank accounts. That’s how PayPal works in the US, that’s how money management mutual funds work, and yes that’s how M-PESA works. If these players don’t take on credit risk or engage in maturity transformation, much of the banking regulatory problem goes away. Prudential concerns still apply, but those can be focused entirely on the banks in which these players hold all their liquidity and which are the ones taking the calculated risks on how to invest that money. There are still some operational and technology risks this new type of issuer faces, and they should be regulated and supervised accordingly. The point is: they are much simpler structures, with much more limited and transparent risks. Give them a regulatory structure that fits that. (See here for a fuller description of regulatory issues raised by e-money issuers.)
I keep hearing: but if it’s taking deposits from the public it has to be a bank! Oh the power of labels. Call these limited-purpose electronic account issuers banks if you like. Or not. Stick them under the deposit insurance scheme. Or not. Either way, regulate them for the risks they entail, and avoid a one-size-fits-all regulatory view of what banks ought to be. There is nothing new here. Remember this is how PayPal and money management mutual funds work, and those have not given us the kind of trouble that banks have given us in the recent financial turmoil.
The big regulatory issue raised by banks is not so much the act of taking deposits but the act of investing that money. I’ve heard plenty about reckless lending and reckless investing – these are at the core of every banking crisis. But when have you heard of reckless deposit-taking? Sure, there is a risk that if I make a deposit of $10 it may not get properly registered in my bank’s accounting system and hence never hit my account. But that is vastly easier to monitor and several orders of magnitude smaller risk than banks gambling all the depositors’ money on a real estate bubble, a currency devaluation, or a hare-brained white elephant project by a relative of the bank’s chairman. None of these risks would apply to a limited e-money account issuer.
Some countries are putting in place e-money issuer licenses with proportionate regulations for them, the Philippines, Kenya and Peru among them. Unfortunately, most countries, especially the larger ones like India, Nigeria and Brazil, are holding steadfast to the notion that to issue an account –any account—you must be a full-license bank. That’s a safe position to take, but then don’t be surprised to see Kenya, Peru and the Philippines take the lead in branchless banking and pushing the frontiers of access to finance.
Let mobile operators or other reputable and branded retail players offer transactional account services to clients who are not today being reached by banks. Not because they are ultimately going to be the financial service providers for the masses, but to provoke banks into action. Banking will ultimately belong to banks, because they understand the business of targeting customer needs with differentiated products, doing credit scoring or credit checks which is a service customers really want, and dealing with ever more sophisticated fraudsters. Banks with a broader bouquet of financial services will have a business model advantage because they will be in a stronger position to bundle and cross-subsidize across various financial products that people want. Mobile operators will struggle will all this, their financial offering will always remain limited and hence their business model will remain vulnerable. But they may be more eager to get the ball rolling.
So here’s the challenge for banking regulators: create more competition for services at the base of the pyramid, without in any way undermining the safety of those services. Bankers will thank you for that –eventually.
Millions of the world's poor are unbanked. What can countries and citizens do to close that gap? Join the conversation by following our financial inclusion blog series or tuning into the Closing the Gap: Financial Inclusion event on Thursday, April 19 at 2:00 EST.
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