www.ifc.org/thoughtleadership NOTE 68 • JUNE 2019 Basic Business Models for Banks Providing Digital Financial Services in Africa By Lesley Denyes Digital Financial Services have progressed rapidly since the first mobile-money services in East Africa a decade ago. Their early success in Kenya and Tanzania sent telecom firms, banks, technology firms, and development institutions scrambling to launch similar services. Yet many or most of these new services found only limited success of their own. The process delivered valuable lessons to the industry, however, including insights about scale, effective engagement models, the importance of adopting new technologies and rethinking corporate cultures, and the need for new digital financial services and products. In a 2011 New York Times article, a fintech industry nongovernmental organizations, and mainstream consulting executive referred to the digital financial services (DFS) services. Boutique operations were popping up, too. The industry as a “goat rodeo”.1 The description seemed fitting, concept of fintech was just emerging at the time and, while as mobile network operators (MNOs) were scrambling the term Big Data was becoming better known, no one yet to replicate the M-Pesa mobile money model launched in realized the power of data to drive financial services. Kenya in 2007, without much success. In 2011, there were 123 digital financial service Zantel, one of the first telco-managed money transfer deployments with no data on their usage, compared services ever launched, had failed completely. Wizzit, with 277 deployments today and 118 million active users an early model for a digital bank in South Africa, was globally. 2 The industry has come a long way, and the once struggling to gain traction in the market. Globe & Smart chaotic rodeo now looks more like an orderly herd. Almost telecom in the Philippines had almost no active usage all mobile network operators and financial institutions beyond airtime resellers. And in Bangladesh, BRAC had today provide digital financial services in some way, shape, launched B-Kash as an over-the-counter service that had or form. And while many improvements are still needed, grown exponentially, but the company was struggling to progress is being made both in terms of financial benefits convince customers to convert their cash to digital and for providers and impact on end users. transact directly from their accounts. However, despite strong growth in recent years, financial It truly was a rodeo, with digital players frantically inclusion across Africa remains low. In 2011, 23.2 percent launching different services with little logic or strategy of adults in the region had financial access, versus 42.6 behind them, and those services failing as quickly as they percent in 2017.3 In particular, access through a financial were launched. Many organizations took part, from tech institution grew to only 32.8 percent in 2017. This is a companies and development financial institutions to donors, testament to the limited levels of bank penetration across About the Author Lesley Denyes, Digital Financial Services Practice Group Lead, Financial Institutions Group - Advisory Services in Middle East & Africa, IFC. Her email is ldenyes@ifc.org. 1 This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group. BOX 1 The Banking-Fintech Dynamic Development Space: A Cross-Country Comparison To better understand the interaction between banks likely continue to dominate the market. In-sector offering digital financial services and nonbank fintechs competition may create a positive dynamic of service doing the same, we refer to the earlier framework innovation among banks. as introduced by Matthew Saal et al. (2017), which is Quadrant II (Upper Right): “Partnering” | In this described below. That framework uses two indicators quadrant banks are well entrenched and serve most of as proxies for four identified challenges both banks and the population. However, the strong tech ecosystem will fintechs face in emerging markets. Those challenges are: support innovations offering new value propositions or • low penetration of formal financial services, seeking to take market share from incumbents. Banks • low income and financial literacy levels, can in turn leverage technology to compete. • underdeveloped technology ecosystems, Quadrant III (Lower Right): “Tech Dominance” | • and weak infrastructure. Countries in this quadrant have well developed tech Saal et al. identify two indicators: formal banking ecosystems, while banks have left large segments of the penetration (representing the first two challenges and market underserved. This has created an opportunity for displayed along the y-axis), and venture capital (VC) nonbank innovators to enter the financial services market. investment relative to GDP (representing the second Quadrant IV (Lower Left): “Race to the Finish” two challenges and displayed along the x-axis). | Here we see low levels of bank penetration and From Saal et al: The bubble sizes correspond to the underdeveloped technology ecosystems. Telecom estimated number of unbanked in each country. companies tend to be the most significant local Taking the average venture capital penetration and the tech players, and in some countries have led the least-squares trend line for the interaction of the two digitalization of the financial industry through mobile variables as dividing lines, we get the four quadrants money products. However, banks have a chance to shown in Figure 1: catch up if they choose to adopt innovations before the telecom firms corner the market. Quadrant I (Upper Left): “Bank Dominance” | This quadrant includes economies in which the traditional The focus of this note is on banks offering digital banking sector is already well established and will financial services in Quadrant IV. 100 Canada I II Australia Germany France Western Europe Singapore US* 90 Baltics 2014 Formal Banking Penetration (%) 80 China Poland South Africa 70 Brazil East Asia & Pacific Europe and Central Asia (CA) 60 Turkey Kenya Latin America & Caribbean India 50 Argentina Nigeria 40 Mexico Central Asia South Asia Bangladesh 0 30 Sub-Saharan Africa 20 0 Middle East & North Africa 10 Pakistan IV III AVERAGE -2 0 3 4.88 8 13 18 23 2015 Venture Capital Investment per US$10,000 of GDP (Bubble size corresponds to the estimated unbanked population in each country / region.) FIGURE 1 The Banking-FinTech Development Space Source: Saal, Matthew et al. 2017. “Digital Financial Services: Challenges and Opportunities for Emerging Markets Banks.” EM Compass Note No. 42, International Finance Corporation. August 2017. 2 This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group. the region as well as the continent’s underdeveloped MNOs launch their own savings and loan products—in the technology ecosystems.4 case of EcoNet Zimbabwe, that meant acquiring its own Despite the low penetration of banks, the business case for bank license—soon customers will no longer be able to digital financial services is now firmly established, and its distinguish between banking with a bank or with a non- impact on the bottom lines of providers is huge. Previously bank. From these customers’ perspectives, it is about ease launched as a customer retention tool for Safaricom, of access. In Africa, where 77 percent of the population is M-Pesa has evolved into a significant revenue stream for the younger than 35, millennials are the driving force behind the mobile network company and now represents 28 percent onboarding of mass market consumer financial products. of its total revenue in Kenya.5 Although digital services And as a 2017 Forbes article put it, millennials would rather represent a more modest 5 to 15 percent of total revenue go to the dentist than a bank branch.9 for most MNOs, it has become clear that demand for such Three basic engagement models for banks services is growing. With many not yet breaking even on a standalone basis, the case for indirect revenue is emerging There are three basic engagement models for banks in for new product development through bank partnerships. DFS: launch singular digital products and channels; launch digital subsidiaries; or transform into a digital bank (in For financial institutions such as banks, opportunities which digital becomes business as usual). Regardless of the for revenue from digital financial services go beyond just approach chosen, it is often fluid, and adopting one strategy fees. Opportunities to source new deposits and to increase does not preclude the simultaneous pursuit of another. cross-selling of transaction-based product sales could have a significant impact on these institutions’ cost of funds, In Africa, most banks so far have made some investments while moving transactions through digital channels reduces in digital products and channels such as ATMs, POS, their cost-to-income ratios, a key metric for defining the mobile banking apps, and standalone agent networks. profitability of a bank. According to a 2017 report by Examples include CAL Bank Ghana and CRDB in Boston Consulting Group, moving to digital can increase a Tanzania, both of which have launched mobile banking bank’s revenue by up to 20 percent, decrease expenses by 30 apps and agent banking. percent, and lower its cost-to-income ratio by 12 percent.6 The digital subsidiary is a model in which the bank Recent IFC longitudinal research followed nine financial maintains the status quo and launches a new subsidiary institutions offering DFS in Africa. Transactions through as a challenger bank in the market. This model was made banking agents (that is, through individuals or entities popular in Europe and North America with new banks like authorized by a bank to act on its behalf within a defined Tangerine, which was launched by the Dutch bank ING in scope of transactions)7 were 25 percent less expensive than Canada (now owned by the Bank of Nova Scotia). There teller transactions at one financial institution and 17 percent are a few examples in Africa too, including Alat Bank in less expensive at another.8 Regardless of competitive pressure Nigeria, owned by Wema Bank. or customer demand, this alone is a big incentive for banks There is growing interest in the financial industry for the to go digital. As a result, they are doing so in droves. adoption of a more radical digital transformation into Most commercial banks now have some sort of digital a digital bank where digital drives the existing banking product or channel such as ATMs, cards, Point of Sale model and includes everything from back-end customer (POS), or mobile banking. Some have their own agent relationship management (CRM) to front-end mobile networks and offer agent banking services. Many more applications for customers, for a seamless customer offer bank-to-wallet integrations to the local mobile wallets experience through the entire digital channel. Digital banks in their markets in order to leverage the vast agent cash-in/ rely on the use of open banking infrastructure to provide cash-out networks built by the mobile network operators. access to fintech partners. Examples in Africa include Thus, most of the participants in the rodeo have joined the Equity Bank and Co-op Bank in Kenya. herd in some way or other, and providers, services, and In a digital bank or digital subsidiary approach, financial customer experiences are converging in an orderly fashion. institutions often partner with fintechs to leverage As a result of this convergence, the lines between mobile technology or data or to offer new products to customers. network operators, banks, and fintech services are beginning In the most sophisticated markets (such as Quadrant II in to blur. As banks move to omni-channel approaches and Figure 1), banks are partnering with fintechs to create an 3 This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group. ecosystem where demand and markets are growing around operators grew their user bases substantially over the last new customer acquisition and better service offerings.10 several years that scale does not guarantee profitability. Investments in two key areas are needed to transform an However, with second-tier banks with smaller transaction existing bank. They are technology and culture, and both sizes, frequency of usage may have a stronger impact on the have proved difficult to change. Banks need to start with overall business case. technology. Legacy systems hinder growth and innovation, Within the current IFC DFS portfolio, marginal expenses yet it can be painful for banks to abandon them, as they of transactions represent, on average, 70 percent of total represent significant investment, costs, and time, as well transaction costs, meaning that marginal costs don’t as many key decisions made by managers who may still be diminish significantly as the customer base grows. So, if employed and protective of them. Removing these systems expenses can’t be reduced by scaling, DFS providers need exposes bad decisions and expensive mistakes. But once it’s to earn greater average revenue per user, or ARPU. This is done, an institution can begin anew and build for the future. done by cross-selling, which requires more products and Tomorrow’s banks will require very open banking more partnerships to offer these products. systems through application programming interfaces The business case can be further developed through the (APIs). Sophisticated manipulation of data using artificial second generation of digital financial service products, intelligence requires the availability of data warehouses which are emerging and widely used in some markets such that will allow all players and partners in the market to as Kenya. First generation products included basic savings, initiate, authenticate, transact, and settle in real time, loans, person-to-person transfers, and bill payments. enabling customers to do everything from buying goods Second generation products are focusing on payments through ecommerce directly linked to their accounts to through platforms such as merchant payments, ecommerce, borrowing money to buy an asset such as a refrigerator or and supply chain management, as well as data-driven a motorcycle, and having the asset tracked, monitored, and lending backed by these platforms, which have taken off even stop working if loans aren’t repaid. in recent years. However, new data suggests that these Like its legacy systems, an institution’s culture often needs products may come with significant challenges. According an overhaul, too. A culture of innovation allows staff to to a recent paper from the Consultative Group to Assist the ideate and create without fear of failure. Rapid iteration of Poor, 35 percent of Kenyans have borrowed using digital products and services will embrace failure, retool, and pivot credit, and of those borrowers, 35 percent borrow from quickly, and will provide an environment where banks can multiple sources and 50 percent have made late payments.11 better respond to the needs of customers and become truly New product development for digital lending requires both customer-centric. sustainable and responsible approaches. For a corporate culture change to succeed, it must be Many providers are partnering with emerging fintechs to aligned with business direction and led by the CEO, guided offer these services, as they are outside of these providers’ core by the board, and executed throughout every level of the business models. APIs, sandboxes, and interoperability will institution in terms of physical presence of workspace, further enable development of these second-generation models. performance metrics, and communication culture. In China, where merchant payments are dominated by the WeChat app and AliPay, mobile payments reach an annual The Need for Products to Balance the Business Case volume of approximately $5.5 trillion; 50 times as much as the The future brings the need for new products. The third United States, with just four times the population.12 Payments model for digital engagement is to launch digital products are fully integrated in the app’s ecosystem. And with WeChat’s or channels to service new or existing customers more open API, users can do everything from book and pay for efficiently or with products previously unavailable such a dog grooming appointment to source new suppliers for a as data-driven insta-loans. Over the last six years, IFC manufacturing business and apply for a trade financing loan has learned from its DFS implementations in Africa that to support the expenses. product diversification is critical to financial success. When DFS was first emerging, it was widely believed that success Driving Impact from DFS was a matter of scale: build it, get to scale, and success will For end-users, easy access to financial services is not follow. Yet it became clear as banks and mobile network only driving financial inclusion, it is also driving impact. 4 This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group. The Partnership for Financial Inclusion, a joint initiative saved at least some of their income in their new digitally- between Mastercard Foundation and IFC, was started linked bank accounts experienced less food insecurity in 2012 with the hypothesis that supporting financial regardless of their income level. In other words, poorer institutions to build new digital products and channels farmers experienced less hunger than their richer neighbors would lead to better access to finance and drive financial if they used their digital savings account. Similarly, inclusion, which in turn would help to reduce poverty. Massachusetts Institute of Technology researchers found Since then, the IFC/Mastercard partnership has supported that access to mobile money services lifted 194,000 Kenyan 15 financial institutions in Africa and crowded in funding households, or 2 percent of households in the country, out to support 20 more, for a total portfolio of 35 digital of extreme poverty.14 financial service providers across Africa and the Middle Going forward East. Together, those institutions have reached 35 million new DFS users. To put that into perspective, the IFC/ Where, then, is the digital financial services herd headed? Mastercard partnership has supported financial inclusion There has been a clear market shift and digital financial for a population larger than the size of an average country. services have gained a foothold across Africa, one that cannot be ignored. As we move forward, there will be a few So, what happens when a customer accesses financial providers that break out of the herd and truly innovate. service digitally? IFC conducted a randomized control trial in Senegal with one of the partners and discovered There is also a clear message that has emerged: If banks that customers who signed up for an account through don’t have a digital strategy by now they are at risk agents became better customers and were more financially of seriously depleting their value proposition to their included. They transacted 140 percent more, they saved 80 customers and losing market share. Customer-centricity percent more on average, and they had higher trust levels is key, and with it, breaking down barriers to access and with the bank.13 Their personal attachment to the bank creating a seamless experience for financial services. increased even though their customer interactions were outsourced to an agent. ACKNOWLEDGMENTS The author would like to thank the following colleagues This may sound counterintuitive, yet it’s not. Consider for their review and suggestions: Martin Holtmann, Barclays’ first use of ATMs in the United Kingdom in the Manager, Financial Inclusion, Financial Institutions Group, 1990s. These ATMs were initially kept online only during IFC; Momina Aijazuddin, Global Head of Microfinance and business hours due to fears that after-hours withdrawals Principal Investment Officer, Financial Institutions Group, could create a liquidity crisis. With much fear and IFC; Joseck Mudiri, Digital Financial Services Practice Group trepidation, the ATMs were eventually made available at all Lead, Financial Institutions Group - Advisory Services in hours. The surprising result was that customers withdrew Middle East & Africa, IFC; and Thomas Rehermann, Senior less. Why? Because with easy access to their money Economist, Thought Leadership, Economics and Private when they wanted it, customers no longer needed to keep Sector Development, IFC. large sums of cash for emergencies during evenings and Please see the following additional EM Compass Notes weekends. Today the same is true for customers of African about digital financial services in emerging markets: banks that offer digital channels such as agents. When they The Case for Responsible Investing in Digital Financial transact through an agent, their transactions become more Services (Note 67); How a Know-Your-Customer Utility Could personal, more local, easier, and more accessible. Increase Access to Financial Services in Emerging Markets It is clear that the provision of digital financial services (Note 59); Modelo Peru: A Mobile Money Platform Offering creates new customers. But it also raises the question, what Interoperability Towards Financial Inclusion (Note 54); happens after a customer becomes a DFS user? Blockchain in Financial Services in Emerging Markets—Part II: Selected Regional Developments (Note 44); Blockchain In 2016, IFC conducted research in Côte d’Ivoire with in Financial Services in Emerging Markets—Part I: Current smallholder farmers who were being paid for their cocoa Trends (Note 43); Digital Financial Services: Challenges and harvests using mobile wallets linked to savings accounts. Opportunities for Emerging Market Banks (Note 42); Can The researchers disaggregated the farmers into quartiles Blockchain Technology Address De- Risking in Emerging by income, from poor farmers to higher-income farmers. Markets? (Note 38); How Fintech is Reaching the Poor in Those farmers who were paid using mobile money and Africa and Asia: A Start-Up Perspective (Note 34). 5 This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group. 1 Seigel Bernard, Tara and Claire Cain Miller. 2011. “Swiping is the Easy Part.” The New York Times. March 23. www.nytimes.com/2011/03/24/ technology/24wallet.html. The article quotes Drew Sievers, CEO of mFoundry, a company offering mobile payment software for banks and merchants, as saying: “It all comes down to who gets paid and who makes money. You have banks competing with carriers competing with Apple and Google, and it’s pretty much a goat rodeo until someone sorts it out.” 2 GSMA. 2017. “State of the Industry Report on Mobile Money.” www.gsma.com/mobilefordevelopment/wp-content/uploads/2017/03/GSMA_State-of- the-Industry-Report-on-Mobile-Money_2016.pdf. 3 Global Findex Database, 2017. 4 Saal, Matthew, Susan Starnes and Thomas Rehermann. 2017. “Digital Financial Services: Challenges and Opportunities for Emerging Markets Banks.” EM Compass Note No. 42, IFC, August 2017. 5 Safaricom Annual Report. 2018. www.safaricom.co.ke/annualreport_2018/financial_review.pdf. 6 Saleh, Aymen, Emma Bunnell, Nadjia Yousif, Ralf Dreischmeier, Christophe Duthoit, and Roman Regelman. 2017. “Why Aren’t Banks Getting More from Digital?” Boston Consulting Group. https://www.bcg.com/publications/2017/why-are-banks-not-getting-more-from-digital.aspx. 7 See also Tarazi, Michael and Paul Breloff. 2011. “Regulating Banking Agents.” CGAP Focus Note No. 68, March 2011. 8 Rodriguez, Christian, Julia Conrad, Gisela Davico, and Susie Lonie. 2019. “A New Banking Model for Africa: Lessons on digitization from four years of operations.” IFC. https://www.ifc.org/wps/wcm/connect/ccfc72e8-1434-4fcb-9262-990fb864e22c/Longitudinal+study_New+Banking+Model+for+Africa_ final.pdf?MOD=AJPERES. 9 Conway, Zach. 2017. “Why More Millennials Would Rather Visit the Dentist Than Listen to Banks. Forbes. April 19. https://www.forbes.com/sites/ zachconway/2017/04/19/why-more-millennials-would-rather-visit-the-dentist-than-listen-to-banks/#3171dee472b3. 10 Saal et al. 2017. 11 Kaffenberger, Michelle, Edoardo Totolo, and Matthew Soursourian. 2018. “A Digital Credit Revolution: Insights from Borrowers in Kenya and Tanzania. CGAP Research & Analysis. October. 12 Keenan, Charles. 2018. “WeChat Pay and Alipay are Dominating Payments in China. What Could This Mean for the U.S. Market?” Ngenuity Payments Journal. www.tsys.com/news-innovation/whats-new/Articles-and-Blogs/nGenuity-Journal/wechat-pay-and-alipay-are-dominating-payments-in-china- what-could-this-mean-for-the-us-market.html. 13 Buri, Sinja and Fabian Reitzug. 2018. “Do Agent Networks Help to Boost Savings?” IFC. https://www.ifc.org/wps/wcm/connect/1d2b4b46-1c9f-4b9b- 9de4-c6dfae8c65b5/Research+Report+Can+agent+networks+boost+savings.pdf?MOD=AJPERES. 14 Matheson, Rob. 2016. “Study: Mobile-Money Services Lift Kenyans Out of Poverty.” MIT News. news.mit.edu/2016/mobile-money-kenyans-out- poverty-1208. December 8. This material is copyrighted. Copying and/or transmitting this work without permission may be a violation of applicable law. All names, logos and trademarks are the property of IFC and may not be used for any purpose without the express written consent of IFC. 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