www.ifc.org/ThoughtLeadership Note 42 | August 2017 Digital Financial Services: Challenges and Opportunities for Emerging Market Banks A digital transformation is taking place in the financial services industry, with a host of non-bank innovators offering both customer facing and back office financial technology products and services. This transformation includes emerging market economies, and in many places offers a viable digital alternative to traditional banks, which have left significant populations underbanked. This note explores the challenges and opportunities that financial technology innovations present for banks in these nations. The digital transformation that has upended industries from will enable them to broaden financial access, introduce new retail and media to transport and business-to-business products and services, and serve customers more efficiently by commerce is now sweeping the financial services industry. This deploying new technologies internally or in partnership with was inevitable, as ubiquitous computing power, pervasive external innovators. connectivity, mass data storage, and advanced analytical tools can easily and efficiently be applied to financial services. After Digital transformation in financial services all, money was already extensively (though not exclusively) Although financial services have been computerized for created, used, stored, processed, and delivered electronically. decades, with products such as retail brokerage using digital Immediacy and personalization have become the norm for channels for some 20 years, a more radical transformation of consumer goods and services. Consumers have rapidly become the industry was delayed due to market advantages of accustomed to making purchases with a touch of their finger traditional financial services providers. These included the wherever they may be, receiving tailored recommendations, established trust of customers, regulatory barriers to entry in choosing customized products, and enjoying delivery of almost banking and insurance, and supervisory approaches that created any item directly to their front door. Businesses failing to adapt a bias to internalizing all or most of the value chain. quickly to these technological developments can fail The 2008 financial crisis reduced trust in financial institutions, dramatically, and many have already done so, including Tower and the regulatory response to the crisis, including increased Records, Borders Books, Blockbuster Video, and countless capital requirements and compliance costs, and made it more travel agents and brick-and-mortar retailers. Consumers’ new difficult and expensive for banks to lend. 2 Paradoxically, this expectations apply to financial services as well. created an opportunity for less regulated, technology enabled non-banks to thrive. They could offer financial services more Technology has transformed business-to-business and within- cheaply and efficiently than incumbents burdened with legacy business interactions, too, enabling reconfiguration of design, infrastructure and regulation. production, marketing, delivery, and service functions through distributed supply chains, freelance design, outsourced In addition, digital transformations of other industries made manufacturing, and contract warehousing and delivery. These customers more trusting of and comfortable with tech-based reconfigurations are mediated by online marketplaces and financial solutions. It also increased their demand for distributors, and assisted by back-end support operations and immediacy and customized products and services. Some of the data analysis that together drive better risk assessment, faster most prominent FinTech companies are meeting these fulfillment and more efficient customer service. consumer demands with low cost, convenient ways to transfer money, borrow, and invest. The same types of disruptive market innovations and reconstituted value chains are now emerging in the financial The impact of FinTech on financial services, however, goes services industry.1 This poses distinct challenges for incumbent beyond retail and customer-facing applications and services to providers such as banks, finance companies, microfinance include all elements of the financial services production institutions, and insurance companies, as financial process. The transformations in other industries demonstrated technology—or FinTech—innovators enter their markets. how increased availability of data and speed of information Incumbents, too, can benefit from these developments, which transmission could address key issues in contracting and monitoring that had determined the structures of firms and the now mandated in some jurisdictions, notably the European degree of internalization of activities. For example, the ability Union.3 The digital transformation of financial services is likely to send designs across the world and monitor the quality of to result in more competition, with significant portions of production has enabled the separation of design and marketing banks’ products and profitability at risk. Barriers to entry may from manufacturing and logistics in companies such as Apple have risen in terms of core bank compliance costs, but and Nike. regulators’ willingness to countenance non-bank competitors in product areas traditionally dominated by banks has increased, Yet commercial banks are still internalizing almost all aspects and the economics of banking have shifted. Cloud infrastructure of channels, product design, and operations as well as a fair and mobile channels mean that the provision of financial amount of private infrastructure (with call centers being an services no longer requires high fixed-cost mainframe data occasional exception, though many such operations were centers and branch networks, so costs are more variable. offshored rather than outsourced). While there may be consolidation in certain lines of business New FinTech entrants can optimize a single link of the financial that have very large scale or network economies, at the same services value chain to provide a bank-beating solution that can time it is increasingly easy for niche providers to offer tailored connect to the rest of the financial ecosystem. That might mean solutions to a particular market and be profitable with a much delivering services directly to users’ mobile devices instead of smaller asset base. Fintechs have taken market share in high using bank branches, dispensing with proprietary margin slices of banking such as remittances and asset communication lines by using encrypted Internet transmissions, management, and technology-enabled challenger banks have or avoiding the cost of data centers by utilizing cloud emerged as serious contenders in a number of markets. computing. The reconfiguration of value chains is also crossing industry There are FinTechs offering point solutions in product areas boundaries. SoFi, an online personal finance company offers such as payments, remittances, savings and investments, career coaching, while Holvi, a Finnish-based financial startup, personal financial management, trade and invoice finance, provides bookkeeping services and cash flow tracking.4 small and medium-sized enterprises (SMEs), lending, and Similarly, data analytics company Atsora, a Polish provider of insurance. SME financial management tools, offers its products to SMEs Innovations are also directed at processes such as Anti-Money through banks and in turn leverages the data to create cash flow Laundering-Know Your Customer (AML-KYC) compliance, based scoring the banks can use to lend.5 credit scoring, underwriting and risk management, customer As the financial services industry becomes increasingly service, collections and recovery, capital markets activities, contestable, decomposable, and reconfigurable, the capacity to asset securitization, middle- and back-office reporting, trade innovate will be a key success factor. Banks that learn to adopt processing, and connectivity between banking systems. new technologies, adapt their products and processes, and While this note largely takes a functional or product oriented become more adept at delivering tailored solutions to their approach, the potential also exists for innovative technologies customers will succeed. Given banks’ preoccupation with the to change the scope of what is possible in financial services and global financial crisis and regulatory requirements, non-bank disrupt traditional intermediation roles. Technologies with innovators have been leading, or have acted as catalysts for, the radically transformative potential include digital identities and digital transformation of financial services. currencies, distributed ledgers, big data, artificial intelligence, Yet incumbents are increasingly catching on. Just as brick-and- and machine learning. These are already being incorporated mortar giants Wal-Mart and Target responded to the online into specific products and solutions in familiar institutions, but threat from Amazon with strengthened online presences of their may in time fundamentally transform financial intermediation. own as well as modified physical channels such as pick-up locations, almost every financial services provider, from banks Impact on financial services value chains to credit unions, now has Internet and mobile channels, and Some FinTechs aim to operate separately from—and compete many are adopting new technologies across products and directly with—banks. Others offer solutions to banks. Virtually processes as well. FinTech innovations can help banks deliver all of them need to connect to other financial services and to enhanced risk assessment, reduce transaction costs, make existing infrastructure (for funds transfers, for example). And operational back offices more efficient, lower fixed asset banks, whether they want to or not, will be dragged into this age investment requirements, and enter new markets. At the same of reconfiguration by market forces and, in some cases, by time, banks can help FinTech innovators address their target government interoperability mandates. markets. Adoption of new technologies by incumbents has been Where unitary proprietary bank systems once precluded aided by the use of standardized Application Program connection to external solutions, interoperability that will help Interfaces (APIs) and the availability of plug-and-play third- FinTechs to carve off profitable slices of banks’ businesses is This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group. party technologies, as well as an increasing willingness to The banking-fintech dynamic development space: a cross- partner to deliver value to a jointly shared client base. While country comparison sharing customers is difficult, collaboration has been To provide a more quantitative comparison across countries, in increasing. Figure 1 we use two indicators as proxies for these four challenges: FinTechs have come to realize that most will not reach scale We measure formal banking penetration (representing the first without leveraging the customer base and capital that banks two challenges, and displayed along the y-axis) and venture have already accumulated, while banks now acknowledge that capital (VC) investment relative to GDP (representing the last internal product innovation processes do not always meet two challenges, and displayed along the x-axis). The bubble customer expectations in terms of time to market or quality.6 sizes correspond to the estimated number of unbanked in each Both can benefit from partnerships that reconfigure financial country. services value chains. Taking the average venture capital penetration and the least- What is different in emerging market economies? squares trend line for the interaction of the two variables as E-commerce, online media, and new models in transport are dividing lines, we get the four quadrants shown in Figure 1: making inroads in developing economies. Financial services Quadrant I (Upper Left): “Bank Dominance” transformation is also underway—and in some countries has This quadrant includes economies in which the traditional outpaced the adoption of technology-driven business models in banking sector is already well established and will likely other industries. Mobile money adoption in Kenya and continue to dominate the market. In-sector competition may Bangladesh is an example. Still, there are specific challenges create a positive dynamic of service innovation among banks. for the digital transformation of financial services and the Examples include Alior, Idea, and mBank in Poland.7 development of FinTech in most emerging market countries. Four key challenges that have affected the digital With only nascent local tech ecosystems, innovation may come transformation of financial services in these markets, relative to from foreign FinTechs. Regulators may seek to create an open advanced economies, are: environment for non-bank entry in order to foster competition and product and service innovation, but entrenched local banks enjoy a “home field” advantage. • Low penetration of formal financial services • Low income and financial literacy levels Quadrant II (Upper Right): “Partnering” • Underdeveloped technology ecosystems, In this quadrant banks are well entrenched and serve most of • Weak infrastructure. the population. However, the strong tech ecosystem will support innovations offering new value propositions or seeking Not all of these factors are present to the same degree across to take market share from incumbents. emerging market economies, but they shape the landscape for the provision of financial services both by banks and FinTechs, Banks can in turn leverage technology to compete. Some as well as the interactions between those two types of financial FinTechs will scale up on their own, while others will partner service providers. with banks for better access to customers, capital, payments systems, or other operating assets. Box 1: Challenges for Banks and FinTech Companies in Examples include OnDeck Capital, which partnered with Emerging Markets: JPMorganChase for customer origination and balance sheet placement while providing the loan decision making and 1. Low levels of formal financial services (cash servicing, and TransferWise, which markets itself as a bank dominance in transactions, informal credit and savings) disruptor while partnering with banks for distribution. 2. Lower income and financial literacy levels (low value transactions, smaller fees, need for user Quadrant III (Lower Right): “Tech Dominance” education) Countries in this quadrant have well developed tech 3. Underdeveloped technology and venture capital ecosystems, while banks have left large segments of the market ecosystems (shortage of skilled tech/finance underserved. This has created an opportunity for non-bank entrepreneurs, small markets, limited revenue innovators to enter the financial services market. potential) The regulatory environment and the extent to which it is open 4. Relatively weak infrastructure (underdeveloped to the FinTech sector varies across countries. This is a key payment systems, customer credit data, legal variable in determining the balance between FinTech and more enforcement mechanisms for payment obligations, traditional banks. China, for example, has been relatively open power, telco/Internet coverage). to big tech companies entering financial services. Ant This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group. Financial, a Chinese FinTech, has more than 450 million significant local tech players, and in some countries have led clients, ten times the number served by any one of the world’s the digitalization of the financial industry through mobile largest banks and equivalent to about 60 percent of the number money products. However, banks have a chance to catch up if of bank accounts in China.8 India, on the other hand, has they choose to adopt innovations before the telecom firms introduced new types of financial services licenses while corner the market. continuing to require that these new services be conducted by licensed and regulated institutions. For example, in Peru the Association of Banks, along with individual banks, mobile phone companies, and the government This regulatory environment has resulted in more cross-sector launched BIM (billetera movil or mobile wallet) in 2015 as a convergence as some tech companies obtain financial services mobile money platform for interoperable services offered by licenses while others partner with banks, and banks seek new both financial institutions and mobile phone companies.9 functionality via partnerships with FinTechs. Quadrant IV (Lower Left): “Race to the Finish” This created an opportunity for banks to innovate alongside Here we see low levels of bank penetration and underdeveloped telecoms in providing digital financial services. technology ecosystems. Telecom companies tend to be the most Figure 1. The banking-fintech development space Source: IFC staff calculations; World Development Indicators, The World Bank, 2016; Global Findex, The World Bank; PitchBook Data, Inc. 2016. Emerging market banks: challenges and opportunities in This, coupled with China’s advanced educational system and its Quadrants III and IV active participation in global supply chains, has resulted in a Most developing countries fall into Quadrants III and IV are strong tech ecosystem including large local tech firms, strong characterized by lower levels of both funding for technology engineering and business skillsets, and active private equity and innovation and of banking penetration. Three country examples venture capital investors. Thus, the challenge of developing illustrate the dynamics of Tech Dominance and Race to the technology and VC ecosystems has largely been overcome in Finish in selected countries. China. Example 1: “Tech Dominance” (Quadrant III) - China Investment in financial infrastructure such as China Although China’s average income is relatively low, the size of UnionPay—the only authorized interbank network in China— its middle class is roughly similar to the population of Europe. has also created a different set of initial conditions relative to This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group. the infrastructure challenges noted in Box 1 above. There were Example 2: “Tech Dominance” (Quadrant III) – India 5.4 billion outstanding payment cards issued in China by the Like China, India has a world-class tech industry set against the end of 2015, or about four per person.10 Purchasing volume by backdrop of a financial services industry that does not yet serve payment cards grew to $8.4 trillion in 2015, equivalent to 77 the mass market and small enterprises. A robust tech sector percent of GDP.11 China’s non-bank payment institutions based on world-leading software and information technology handle 54 percent of transactions, compared with 46 percent by companies has developed over recent decades. This has created traditional lenders.12 a tech ecosystem, including skills and capital, that is supporting a burgeoning FinTech sector, including innovators in payments, China’s retail loan penetration rate is around 20 percent, among digital small enterprise and retail lending, personal financial the lowest in the world.13 Its banking sector prioritized state- management, and insurance. owned enterprises and influential borrowers over SMEs and the wider retail market. India’s tech sector had been held back by regulation that limited Responding to the market gap, over two thousand peer-to-peer unlicensed entities from performing banking activities while lending platforms are in operation in the country, with the maintaining high barriers to obtaining a banking license. volume of peer-to-peer transactions as high as RMB 252.8 However, new regulations announced in 2014 will enable tech billion (USD 37 billion) in value by the end 2014, and that companies to compete. Many FinTechs have already obtained figure quadrupled in 2015.14 or sought licenses. However, a number of prominent platform failures resulted in Important advances in infrastructure, especially digital identity new regulation on loan sizes and required custodian that can be linked to bank accounts, have provided an arrangements for investor funds. Growth slowed in the first half opportunity to reduce the cost of customer on-boarding and of 2016, with more than 500 platforms closing down. Further ongoing compliance. This enables financial institutions to reach consolidation is likely as compliance costs kick in and unsound hundreds of millions of new customers. These advances in platforms are weeded out.15 regulation and infrastructure are paving the way for increased provision of financial services from both traditional and non- The large and growing middle-income segment created market traditional providers. momentum and critical mass for service providers who can leverage that base of activity to serve poorer segments as well. The demonetization of notes announced in November 2016 has As a result, China’s alternative finance sector, which includes accelerated the shift from paper to electronic payments and not only the peer-to-peer lenders but also big tech companies added momentum to the technology-driven transformation of active in financial services and other FinTechs, rapidly financial services in India. outpaced most developed and developing markets. While peer- to-peer transactions will continue to grow, tech companies will Payments banks were conceptualized by the Reserve Bank of play a bigger role in the financial sector. India in 2014 as a new model to increase access to financial services for unbanked or underbanked groups such as small In 2015 alone, Alibaba’s online payment platform, Alipay, had businesses, low-income households and migrant workers. The 451 million annual active users and 153 million daily two main differences between a payments bank and a traditional transactions.16 Alibaba’s Ant Financial has become the largest bank are that the former can only accept deposits of up to FinTech company in the world by market value.17 Beyond 100,000 Rupees ($1,550) per account and are not allowed to online payments, the tech giants of China expanded their reach issue loans or credit cards.20 to lending services in 2016. Tencent, Alibaba and Baidu established WeBank, MYBank and Baixin bank respectively, Low-cost, paperless operation through mobile phones could with the aim of helping SMEs gain easier access to capital.18 allow payments banks to address market segments characterized by low value/high volume transaction. In 2015, While tech companies seem to have the growth edge relative to the Reserve Bank granted eleven companies, including the banks, there is evidence that banks are waking up to the country’s biggest mobile service providers, “in-principle” innovation imperative and the underserved market of SMEs and licenses to launch payments banks.21 innovators.19 At the same time, retail depositors have learned that promises of high returns from some peer-to-peer lenders The first live payments bank was launched in January 2017 by were too good to be true. Airtel, a mobile network operator. India’s largest digital goods Although FinTechs linked to tech businesses like Tencent, and mobile commerce platform, Paytm aims to have its new Alibaba, and Baidue are building significant financial services payments bank open 200 million banking and mobile wallet brands, it may prove challenging for a broad range of accounts within the coming year.22 standalone startups to develop sufficient client trust to compete A key element of the support infrastructure needed to reach at scale with China’s tech giants or traditional banks. more customers has been provided by the Unique Identification Authority of India (UIDAI). This government agency, which is This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group. the world’s largest national identification number project, has Others, such as KredX, are creating digital platforms for invoice enrolled more than a billion residents of India since September finance.28 Lenders must either obtain a license or book the loans 2010.23 UIDAI issues Aadhaar identification numbers, through a bank or Non-Banking Financial Company (NBFC); collecting demographic, biometric and other details during thus a number of tech companies have partnered with licensed enrollment. The Aadhaar number can be used for paperless institutions. Since the new lending platforms lack a low-cost identity verification when opening a financial account, reducing deposit base, most of these lenders are funded by banks and the risk of identity fraud. institutional investors. Peer-to-peer lending, which serves a combination of retail and micro/small and medium enterprise This allows banks to fulfill their Know Your Customer, or borrowers, has also been growing rapidly. Currently covered KYC, requirements for hundreds of millions of new customers. only by the Negotiable Instruments Act, these lenders may be Aadhaar-enabled e-KYC processes could halve costs and time put under a new non-bank finance company category of relative to paper-heavy processes.24 Some 34 banks have used Reserve Bank licensing.29 e-KYC to open over three million bank accounts across the country, contributing to a fourfold year-on-year increase in In November 2016 the Indian government announced the India’s mobile banking transaction value by the end of demonetization of large denomination bills, with the aim of December 2015.25 combatting tax fraud, counterfeiting, and corruption. This removed 86 percent of currency in circulation, spurring a sharp The identity infrastructure can be linked to the payments increase in electronic payments, including interbank fund infrastructure of the National Payments Corporation of India to transfers, retail bankcard, and mobile wallet transactions.30 access funds and route payments to an individual’s phone or bank account. The Aadhaar Enabled Payment System allows Mobile banking and digital payments service providers such as the individual to use Aadhaar data for authentication rather than FreeCharge, Ola Money, Oxigen, and Paytm, as well as bank a debit card, in order to perform financial transactions at a offerings including ICICI Pockets and Axis Bank’s LIME have banking correspondent. The Unified Payments Interface allows benefitted. Whether this momentum will persist after new cash a bank account to be linked to phones and apps. notes come into circulation remains to be seen, but even a return to the previous trend will mean a continued shift to electronic At the start of 2017 the government launched an inter-operable payments. In March 2017 Amazon was awarded a mobile payment app, Bharat Interface for Money, which became a wallet license, adding another big player to the market31, and in popular download.26 DigiLocker, a platform for issuing and May 2017, SoftBank announced a $1.4 billion investment into verifying digitally signed documents and certificates, was Paytm, joining previous investor Ant Financial in helping to recently integrated with UIDAI and will allow further expand the company, which aims to serve 500 million streamlining of financial services. customers in three years.32 This “India Stack” of technology built upon Aadhar will With its investment in digital identification, tiered licensing for improve credit availability as well. Lenders can link a financial services, and other innovations in financial customer’s identity to digital transaction data, enabling more infrastructure, India has addressed Challenges 3 and 4 (Box 1), efficient credit appraisals, and use the payments and document creating an opportunity for financial services providers to focus functions for efficient underwriting, processing, disbursing and on Challenges 1 and 2, reaching low-income customers with loan collection.27 targeted and tailored information and services.33 India has a large SME funding gap that is as much about market Some are actively partnering with FinTechs to expand services size (the number of towns and cities dwarfs the branch numbers and reach and improve efficiency. For example, Fullerton India, of even the largest banks) as it is about traditional banks’ an SME-focused credit provider, has partnered with reluctance to lend except to known borrowers who have Creditvidya, a startup that leverages alternative data for credit sufficient collateral. scoring, to perform automated authentication and verification As in some of the developed markets (Quadrant II), there has checks to improve the efficiency of Fullerton’s loan been strong growth of non-bank alternative lenders addressing processing.34 this gap in small firm financing with innovative digital Given the market gaps and the strong tech ecosystem in India, solutions, quicker turnaround, analytics and credit-scoring FinTechs and new forms of banks have strong potential to driven underwriting and cost effective customer acquisition. dominate significant market segments. The viability of some of These include NeoGrowth, LendingKart, and Capital Float, the current business models, however, has yet to be proved, and technology platforms that lend to SMEs across the country. policy driven changes to pricing, market conditions, and These lenders use cash flow data, digital transaction history, permitted activities will continue to present challenges to and other non-traditional information to build credit profiles. standalone tech players. It seems fitting that this market, whose tech companies enabled so much of the business process outsourcing and offshoring that has changed corporate This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group. operations in developed markets, is now demonstrating how money to poverty reduction through increased financial banks can partner with FinTechs to reconfigure product resilience and improved labor prospects.38 delivery in the home market. The availability of the core payments infrastructure has enabled reconfiguration of the value chain from one in which the Example 3: “Race to the Finish” (Quadrant IV) – Kenya banking system provided savings, loan, and payments products An early adaptor of mobile money,35 Kenya appears in to one in which an external payment infrastructure is Quadrant IV just below Quadrant I, highlighting the expanded interwoven into banks’ products and services. reach of its financial sector thanks to Kenya’s mobile-money system, M-PESA, which was launched in 2007 by Safaricom, This has underpinned the success of new financial products as the country’s largest mobile-network operator. Mobile well as new business models in other sectors such as pay-as- transactions are transforming Kenya’s payments system; they you-go solar. It has also spurred development of the local hit a record $33 billion in 2016 and accounted for 67 percent of innovation ecosystem, as demonstrated by a thriving transactions tracked by the National Payments System.36 community of startups, accelerators, and venture capitalists. In November 2012 Safaricom, together with Commercial Bank Opportunities for Emerging Market Banks of Africa (CBA), introduced M-Shwari, leveraging the M-Pesa Globally, the digital transformation of banking services allows network to provide deposit and lending products directly onto a an expansion of access by leveraging digital channels and phone handset. M-Shwari grew rapidly; by 2014 it had been customer information, and a reconfiguration of product and able to mobilize deposits of $1.5 billion and had disbursed loans process value chains to offer new products and serve customers of $277.2 million. CBA’s market share of deposits rose to 6 more efficiently. In this new context, each of the four challenges percent in 2015 from 4.7 percent in 2012, and its share of the facing emerging market digital financial transformation, as total number of bank accounts grew to 37 percent (12.9 million enumerated in Box 1 above, also presents opportunities. accounts) from 7 percent in 2012 (1.1 million accounts). CBA’s contribution to opening bank accounts represented close 1. Low levels of formal financial services: to 12 million of the total 19 million new accounts in Kenya from Innovations such as mobile money can take hold more 2012-2015, and Equity bank accounted for another 5 million.37 completely in emerging markets where there is a strong need While M-Pesa provided the pipes for CBA’s growth, t he and no incumbent service to displace. Building on the mobile capture of value-add in financial services appeared to shift back money ecosystem, innovators in emerging markets have to the banking sector. leapfrogged conventional financial infrastructures to offer a range of financial services engineered to sustainably service M-Pesa has enabled a number of other advances. Innovators dispersed or low-income populations. have built on top of the payments infrastructure provided by M- Pesa, developing merchant acquisition networks and innovative 2. Low income levels: pay-as-you-go models for durable goods such as solar lights and Operating bank branches is expensive in emerging and panels. That business model innovation has now been replicated developed markets alike, and the shift to digital channels helps in other markets and regions, enabling microleasing of devices reach more customers at lower cost across markets. The that can be remotely controlled and paid for. imperative for complete digital transformation from front-end customer channels, through the credit and payments engines, to This has resulted in a follow-on financial innovation as the solar servicing and processing is greater, though, in emerging hardware companies have become de facto leasing companies. markets where financial access is a goal. Once a device is paid off it can become collateral for further general purpose lending. More recently, the entry of FinTechs In wealthier markets, mobile channels and improved processing using mobile phone data for credit scoring to extend micro- efficiency are add-on benefits to help meet customer loans (Tala and Branch, for example) may shift the innovation expectations and improve profitability. Among low-income lead back to the technology side. communities, however, these are must-have features that enable In another play for the market, Safaricom has recently the sustainable provision of financial services to lower income eliminated fees on low value transactions and reduced the consumers. minimum transfer amount from ten to one Kenya shilling with 3. Underdeveloped technology and VC ecosystems: M-Pesa Kadogo. This essentially makes mobile money a Flying under the radar of the global tech/venture capital costless cash replacement, and potentially positions Safaricom community can create space for local innovators to serve their at the center of the merchant payment ecosystem. markets while the giants are looking elsewhere. For banks, this It is still not clear who will dominate the provision of financial can also create opportunities if they can lead in introducing services in Kenya. For now, consumers are benefiting from unique local value propositions, as CBA did with m-Shwari in reduced prices and increased availability of services, and a Kenya. recent study has demonstrated the contribution of mobile This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group. 4. Weak infrastructure: significant innovation outside the banking system, a huge While forward thinking regulators in some countries have number of marketplace lenders has emerged, and a number of created an environment favorable to digital financial services, tech companies have made significant inroads into financial whether by offering a flexible regulatory environment (Kenya) services, notably in payments and investments. India has also that allowed non-bank infrastructure to develop, or investing in seen a proliferation of new lenders and payment offerings. critical identity and payments infrastructure and a tiered licensing system (India), in many countries much work remains While the marketplace lending and wallet booms in these to be done. countries may not be sustained, the big tech companies in China are well positioned to play a significant role in financial services Where general-purpose financial infrastructure is lacking, the going forward. In India, the banking regulator has taken a more networks and infrastructure of incumbent banks retain conservative approach: innovators must partner with banks or significant value. The opportunity for banks is to leverage their obtain one of the tiered licenses now available. Convergence position of already having payments, identity and trust assets in may be the result. As the infrastructure for digital financial place as new infrastructure comes on-line. Banks can leverage services is rolled out, banks are increasingly partnering with their capital, customer bases, and brands to expand rapidly in innovators even as tech players are looking to obtain payments partnership with Fintechs that can help fill gaps in banks’ bank or other licenses. channels, product sets, and processing capabilities. Across all Quadrants in our mapping, technology enables Conclusion expanded reach and the reconfiguration of product delivery in While the final structure of a digitally transformed financial the financial sector, as it has in other industries. Market position services sector could take different forms, the degree to which and regulatory privilege provide a window in which banks can banks continue to play a role will depend on a combination of continue to lead in the provision of financial services in the initial conditions and adaptability. digital age, but this window will only remain open as long as they innovate to provide what customers need. Banks don’t In markets where the formal banking system is well-entrenched need to accomplish all this innovation by themselves. and had been providing reasonable services to the mass market, banks may continue to play a dominant role—even where the Banks have an opportunity to learn from the experiences of the technology ecosystem can support significant FinTech automobile, electronics, retail, and other industries where incursions. In markets where the banking sector has lagged, product design, production, branding, marketing, delivery, and FinTechs have a greater chance of taking over functions and servicing no longer take place within a single corporate entity, market share. but value chains have been constructed to optimize the best solution at each link. In countries where the tech ecosystem is relatively weak, with only isolated solutions such as mobile money being offered by As markets develop, more will shift to Quadrant II, in which tech companies, banks have thus far been able to catch up. banks partner with technology innovators to provide enhanced Kenya is an example where an extensive FinTech infrastructure products and services to an ever wider customer base. for payments was put in place by a telecommunications company, but the financial services value add has been Matthew Saal, Principal Industry Specialist and Head of reclaimed by banks. Even so, an array of new entrants Digital Finance, Financial Institutions Group, IFC leveraging that technology infrastructure may shift a portion of (msaal@ifc.org) financial services out of the banking sector. Susan Starnes, Strategy Officer, Financial Institutions Group, IFC (sstarnes@ifc.org) China and India offer examples of different potential outcomes in markets where broad penetration of formal banking was low, Thomas Rehermann, Senior Economist, Thought Leadership, leaving a large underserved market, while the tech ecosystems Economics and Private Sector Development, IFC were strong. In China, where the regulator has permitted (trehermann@ifc.org) 1 See World Economic Forum, The Future of Financial Services - Challenges and Opportunities for Banks, Presented at the Sixteenth How Disruptive Innovations are Reshaping the Way Financial Annual Conference on Policy Challenges for the Financial Sector Services are Structured, Provisioned and Consumed, WEF, Final - Finance in Flux: The Technological Transformation of the Report, June 2015; Manyika, James – Lund, Susan – Singer, Marc Financial Sector, June 1-3, 2016, Washington, DC; UBS, Q-Series – White, Olivia – Berry, Chris, How Digital Finance Could Boost - Global Banks: Is FinTech a Threat or an Opportunity? July 26, Growth in Emerging Economies, McKinsey Global Institute, Sept 2016; Dapp, Thomas F, FinTech Reloaded – Traditional Banks as 2016; Citi GPS, Digital Disruption – How FinTech is Forcing Digital Ecosystems Deutsche Bank Research, Current Issues, June Banking to a Tipping Point, Citi Global Perspectives and Solutions, 15, 2016; Kelly Sonja – Ferenzy, Dennis – McGrath, Allyse, How March 2016; Holtmann, Martin, Digital Financial Services – Financial Institutions and Fintechs Are Partnering for Inclusion: This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group. 22 Russell, Jon, Paytm, India’s Top Mobile Payments Firm, Gets Lessons from the Frontlines, IIF Institute of International Finance Approval to Launch Its Own Digital Bank, techcrunch.com, – Center for Financial Inclusion, Accion, July 2017. January 3, 2017. 23 2 Starnes, Susan – Kurdyla, Michael – Alexander, Alex J., De- TNN, Learning with the times: What is Aadhaar?, The Times of Risking by Banks in Emerging Markets – Effects and Responses for India, Oct 4, 2010. 24 Trade, IFC EM Compass Note No. 24, November 2016. Banerjee, Shweta, Aadhaar: Digital Inclusion and Public 3 Ley, Stephen –Bailey, Steven, PSD2 Opens The Door to New Services in India, World Development Report 2016 Background Market Entrants, Deloitte UK, 2015. Paper – Digital Dividends, World Bank, Dec 2015. 4 Dietz, Mikols – Vinayak, HV – Lee, Gillian, Bracing for Seven 25 Puneet Chopra – Paresh Rajde – Vivek Gupta – Priyank Mishra Critical Changes as Fintech Matures, McKinsey & Company, – Akshat Pathak, e-KYC and the India Stack – A Transformative November 2016. Blueprint for Emerging Markets, MicroSave, March 2016. 5 Coleman, Alison, Poland On Track To Becoming a Major 26 Goyal, Vishal –Kuman, Ishank, UBS Evidence Lab – India European Tech Startup Hub, Forbes, May 20, 2016. Banks: Fintech Challengers Gaining Ground, UBS Global 6 Dietz, Miklos – Vinayak, HV –Lee, Gillian, Bracing for Seven Research, February 2, 2017. Critical Changes as Fintech Matures, McKinsey & Company, 27 Memon, Niloufer – Goyal, Vibhor – Pande, Varad, The Five- November 2016. Minute Loan: How India Stack is Speeding Loans to Small 6 Foy, Henry, Poland’s mBank Thrives on Disruption, Financial Businesses, Dalberg.com D. Blog, January 6, 2017. 28 Times, March 4, 2015. Sachitanand, Rahul, Meet the Alternative Lending Startups, The 7 Ibid. Economic Times, August 13, 2016. 29 8 Arnole, Martin, How Finance is Being Taken Over by Tech, KPMG, FinTech in India - A Global Growth Story, KPMG, June Financial Times, January 17. 2017. 2016. 9 Center for Financial Inclusion, BiM – The First Fully- 30 D’Monte, Leslie, India’s Cash Conundrum: How Ready is India Interoperable Mobile Money Platform: Now Live in Peru , Center to Go Cashless?, Livemint.com, January 28, 2017. 31 for Financial Inclusion Blog, Feb 17, 2016. Russell, Jon, Amazon Gains Wallet License to Boost its Business 10 Mak, Liz, China’s 55 Trillion Yuan Credit Card Clearing Market in India, Techcrunch, April 12, 2017. Now Open for Competition, SCMP.com (South China Morning 32 Mundy, Simon, India’s Paytm raises $1.4bn from SoftBank, Post), June 8, 2016. ft.com. May 18, 2017. 33 11 Cheng, Leng, China opens bank card clearing market, KPMG, FinTech in India - A Global growth Story, KPMG, June Shanghaidaily.com, June 8, 2016; BI Intelligence, China Prepares 2016. See also Committee on Digital Payments, Medium Term for Open Card Payments Ecosystem, Businessinsider.com, June Recommendations to Strengthen Digital Payments Ecosystem , 10, 2016. Report by the Ministry of Finance, Government of India, 12 Woodhouse, Alice, Chinese Fintechs Overtake Western Rivals December 2016; Unified Payment Interface Crosses 1mn hits Mark in Innovation, SCMP.com (South China Morning Post), December – Value soars to Rs 457cr, FE Bureau, Dec 27, 2016; N.N., World's 6, 2016. Best Digital Bank 2016: DBS, euromoney.com, 2016; UBS 13 Mittal, Sachin – Lloyd, James, The Rise of FinTech in China – Evidence Lab, India Banks – Fintech Challengers Gaining Redefining Financial Services, EY and DBS, November 2016, p. Ground, UBS, Feb 2, 2017. 34 13. Srinivasan, Supraja, CreditVidya Partners with Fullerton India 14 Asean Today, Unqualified P2P Chinese Platforms Under New for Authentication Service, economictimes.indiatimes.com, Policy, Fintechnews.sg, September 19, 2016. December 7, 2016. 15 Alois, JD, The China P2P Lending Market is Finally Slowing, 35 Cook, Tamara – McKay, Claudia, How M-Shwari Works: The crowdfundinsider.com, January 12, 2017; Asean Today, Story So Far, Consultative Group to Assist the Poor (CGAP) and Unqualified P2P Chinese Platforms Under New Policy, Financial Sector Deepening (FSD) Kenya, Access to Finance FinTechnews.sg, Sep 19, 2016. Forum, Reports by CGAP and Its Partners No. 10, April 2015. 36 16 Ant Financial, Alibaba Investors’ Day Document, Alibaba Muthiora, Brian, New Infographic: Mobile Money and the Group, June 2016 Digitisation of Kenya’s Retail Payments Systems, GSMA, 17 Reuters, Alibaba’s Fintech Arm Says Its Focus Remains on Asia, September 29, 2014. See for a definition of the Kenyan National Fortune.com, Nov 1, 2016. Payments System and its components: 18 Yuanyuan, Deng, Alibaba, Baidu and Tencent and Their New https://www.centralbank.go.ke/national-payments-system/ 37 Online Banks, fintechranking.com, December 26, 2016. Bank Supervision Annual Reports 2015 and 2012, Central Bank 19 Chinese Bankers’ Survey 2015, China Banking Association and of Kenya. PWC, January 2016. 38 Suri, Tavneet –Jack, William, The Long-Run Poverty and 20 Reserve Bank of India (RBI), Guidelines for Licensing of Gender Impacts of Mobile Money, Science, Dec 9, 2016, Vol. 354, Payments Banks, March 2, 2015. Issue 6317, pp. 1288-1292. 21 Reserve Bank of India (RBI), RBI Grants “in-Principle” Approval to 11 Applicants for Payments Banks , August 19, 2015. This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group.