Welcome to Pacific Exchanges. A new podcast from the Federal Reserve Bank of San Francisco. I’m Nick Borst.
And I’m Sean Creehan. We’re analysts in the Country Analysis Unit here at the San Francisco Fed. Our job is to monitor financial sector developments in Asia and, as part of the Fed’s public mission, share information and analysis with listeners like you. We inaugurate the podcast with a series of episodes that look at the state of innovative financial technology, commonly known as fintech, in Asia.
Fintech is a buzzword that gets thrown around a lot, but what exactly is it? One simple definition would be the use of software to provide financial services online or through mobile phones. This can involve banks, but just as often involves startups. fintech firms operate in a number of sectors ranging from lending to personal finance, digital mobile payments, and virtual currencies. We’re excited for you to join us in the episodes to come as we explore how fintech is impacting people’s lives in Asia.
Today’s episode is a continuation of our series on fintech in Asia. We sat down with Sacha Polverini, a senior program officer at the Bill and Melinda Gates Foundation. We invited Sacha to speak with us about the challenge of financial inclusion in Asia, as well as the impact fintech can have on people’s lives.
Thank you for joining us Sacha. Maybe we should start out talking about your work at the Gates Foundation and how your group focuses on financial inclusion.
I’m a senior program officer at the Bill and Melinda Gates Foundation Financial Services for the Poor Program. This is an initiative that is aimed at promoting financial access to people that are currently unbanked and living with less than two dollars per day. There’s two billion people around the world that are currently not served by the formal banking system for various reasons. So this initiative is really trying to promote financial access in a number of countries. We are operating in four African countries and four Asian countries at the moment. Operating means making investment and providing grants and support to the public and private sector. The African countries are Nigeria, Uganda, Tanzania and Kenya. And in Asia we operate in India, Pakistan, Bangladesh and Indonesia.
My role within the team is really to look at the policy and regulatory aspect of the whole ecosystem. We know this is a fast moving environment that is bringing new actors and new players. With the opportunities also come the challenges. Given that regulators are not necessarily up to speed with all these fast moving developments. Therefor when you have a number of new players, non-traditional players, particularly non-financial institutions, coming to the market and providing financial services and products, clearly there’s some friction that occurs in the whole system. For regulators it’s really a challenge to understand how to best provide safety nets. To make sure that the system is stable, secure and competitive without at the same time stifling innovation. Making sure that the new players can be leveraged for their skills and assets in the best way possible.
Other colleagues in the team are looking more on the supply side and demand side. Meaning that we work a lot with the private sector to understand what kind of products better suit the need of the unbanked. So low income households or poor individuals. We try to really develop new solutions, develop new business models so that the product and services that we try to offer for the bottom of the pyramid can be profitable, scalable and successfully marketed in those countries.
How do you measure financial inclusion? How do you define success?
Financial inclusion can be measured through a number of indicators. Success is not something that cannot be attributed to one single organization because there are many players. This is a very crowded space. The Gates Foundation is not the only institution operating in the financial inclusion arena. We work very closely with The World Bank, with the UN, with private sector entities like GSMA, the trade association representing mobile network operators globally, CGAP and then also bilateral organization like DFID. We are hopefully all converging and moving in the same direction so we are not stepping on each other’s toes or just conflicting in terms of objectives and purposes. We are at least trying to synchronize our efforts. So there’s the contribution of the effort of financial inclusion rather than being able to attribute role and merit to any specific individual organization.
In terms of measuring we mentioned many times the role of Findex which is one of the most comprehensive surveys to understand how countries are progressing on the financial inclusion and understanding how women are also progressing on the financial inclusion aspect.
You mentioned Findex. Could you explain to our listeners what Findex is?
Findex is a global survey that is promoted and taken by The World Bank. The last figures were published in 2015, covering the period of 2011 – 2015. So you have a number of indicators of how many adult people have access to a transaction account over the last twelve months. Then it’s desegregated in different categories. That’s creates a baseline against which countries can measure progress for the next round of surveys.
What technologies do you see as most likely to have the biggest impact on financial inclusion moving forward?
Our own strategy is clearly turning around mobile money and digital financial services. We are convinced that the existing infrastructure, the access to a mobile device, is an easy way in. There are a lot of second-hand phones in the market. Although the penetration of smart phones are increasing, particularly in the urban area there is a legacy in the rural and remote areas.
We are convinced that the technology that runs feature phones and smart phones later can provide financial services at the doorstep of the unbanked and the poor. These smartphones probably will create all sorts of different dynamics in the market just because they will be much more intuitive. They are more iconographic than just scrolling down a menu and going through different steps either on the voice recognition system or through the display. That will also change the dynamic in terms of the provision of technology. Given that providing financial services and mobile payment services through feature phone devices relies heavily on the U.S. as the channel or the SMS gateway. Moving to smartphones will change that dynamic because it will be more reliable on wifi, and the internet connection and broadband.
For the technology at some point we’ll see two parallel streams. In the urban [areas] we will probably see a pickup of smartphones, even at cheap price. In the rural areas we will see still a lot of legacy for the years to come. Those technologies will have to run in parallel.
You mentioned earlier that in a lot of countries it’s actually the mobile network providers that are stepping in and almost in some ways taking over where banks previously had operating or where banks should be operating but weren’t necessarily. Could you talk a little about this nexus between the traditional financial system and between mobile network operators. Is it a competitive relationship? Is it a cooperative relationship? How is that developing across countries?
The situation that I observe in different markets is that mobile network operators are increasingly interested in providing payment services to the end users. It’s an opportunity for them to add services and products to the existing voice telephony and data packages. The competition is very fierce. It’s still a business that is not easy to make profitable and scalable. It’s a heavy investment that pays out after a number of years. The MNO’s and the financial institution tend to compete in the payment market. It’s not a very collaborative approach. Although we are seeing an increasing number of partnerships taking place, which is good news, we’re probably moving away, although slowly, from this dichotomy of bank-led and telco-led type of differentiation which creates more conflict than actually focusing on the possibility to cooperate and partners between entities that have different types of skills and assets.
The reason why for mobile network operators it is easier to reach the unbanked is because they are experiencing leveraging a wide network of agents. This is one of the fundamental differences between traditional financial services and the payment system industry. Simply because we are now moving away from the branch, in a way, which is very costly. And moving to a network which is composed of thousands of agents in the field. And these agents can provide cash in and cash out services. They can collect information to open an account. They can pay bills. They can provide mobile money transfer services.
The telecommunication company has those skills because they used to have a wide agent network to offer airtime in the beginning. That doesn’t mean that those same agents will be converted into banking agents. We still have to undertake KYC processes for screening who these agents are because their relationship is going to be different. This is the ground where the mobile network operators are currently eroding market share in the payment system sector from the traditional banking institutions.
When we are moving away from payment and we are thinking about other products, like savings and loans, we are seeing a much more collaborative approach between the two industries. Simply because we are going back to a situation where the telecommunication company provides more of a channel to distribute those services rather than being themselves the providers of the rails and the services at the same time. M-Shwari, which is one example of product that was launched in Kenya as a collaboration between the CBA, the Commercial Bank of Africa, and Safaricom is one example where the joint venture seems to work very well. The product is distributed through Safaricom, instantly accessible through the menu after six months of being a customer of Safaricom, but is offered by the bank and the liability lies with the bank.
There are all these joint ventures, collaborations and partnerships that take place because we are beyond payment and we are thinking about different types of products.
As you talk about the importance of partnerships between, for example, telecommunications firms and financial firms, whether they are startups or traditional institutions, I’m wondering the role of regulators there. Both industries, telecommunications and financial services, are heavily regulated around the world. I understand some of your work is involved in getting more communication between these two different types of regulators. I’m wondering if you could talk about best practices there.
My team and myself traditionally started dealing with financial regulators. There’s no question about the fact that central banks are the lead regulators for payment systems and digital financial services. It depends on the structure of the country. Sometimes you have everything combined in one institution. You have other situations where the financial institution authority is separate from the central bank. This is more responsible for payment monetary policy and inflation.
Let’s say that financial regulators have been for a long time the main kind of counterparty. When we think about the digital financial services world, we shouldn’t forget about the digital piece of the expression “digital financial services” and the role the mobile network operators and other technical companies are playing. We realize there is a need for more dialogue between financial regulators and telecommunication regulators. To really understand what are the roles and responsibilities of each, where the grey areas are and where more collaboration is required, simply because we want to avoid arbitrage. New players can take advantage of loopholes in the system. Also because we want more clarity. We certainly keep an eye to the consumer at the end of the day. Their need to be protected is always the weakest link in the value chain.
There’s an important role, in terms of the dialogue and the collaboration, that needs to take place at the beginning between telecommunication regulators and financial service regulators. And in the second moment you can also include tax authorities, or competition authorities in order to supplement the initial dialogue with other aspects that need to be taken in to account. Particularly in those markets that are highly concentrated.
That dialogue happens in a patchy way most of the time. There are some very good examples of collaboration that are very fruitful. We’ve seen that happening in East Africa. In countries like Tanzania or in Kenya there’s a good collaboration between financial regulators and telco regulators. I think at the national level that certainly doesn’t happen on a systematic basis. Big gatherings, organized for example by the International Telecommunication Union or by the Alliance for Financial Inclusion, both grouping telecommunication authorities or central bank officials, very rarely bring together a representative of the other community. This now happening more and more. It wasn’t the tradition, let’s say. It’s a good sign to start seeing that people realize that collaboration is the way forward rather than working in insiders. One of the important aspects is to try to formalize the relationship between the different regulators. Most of the time that could be done through a memorandum of understanding that really helps with structuring the dialogue between two authorities. Rather than having occasional and sporadic meetings that happen every so often without any sort of regularity or sequence. It’s important to make sure that there are structural committees that gather all representatives of all regulators. There are memorandum of understanding in place so everything is much more framed and we can work in that framework.
Maybe I can ask a quick follow up there and ask you to give an example. In India, this is a country we’ve follow closely in the Country Analysis Unit and have actually done some research regarding financial inclusion. There were earlier efforts to empower mobile payment operators but they lacked the ability to actually provide banking services. Now the Indian government is rolling out new payment banks. I’ve noticed that several telecommunications companies have actually applied for and been granted provisional licenses. I don’t know how closely you follow that specific trend in developments in India. Maybe you could talk a little about that as an example of collaboration.
I think that’s a good example of collaboration and a very creative solution that the Indian government put on the table and introduced to allow non-financial institutions to be more active in this space. The underlying idea is really to separate credit inter-mediation from the politicking and payments. So that these payment banks are narrowly defined financial institution that can provide payment services and can collect deposits from the public. But not inter-mediate those deposits and lend to the economy, exposing themselves to credit risk. I think it’s very creative idea because it allows to separate two very different businesses.
This kind of trend has now been replicated in other countries. Though we are not talking about payment banks. That was a very specific requirement in India that it needs to be a financial institution under the RBI supervision. Other countries, like Colombia for example, talk about specialized entities. Not necessarily to be a bank. Still an entity supervised by the central bank, but it has a different name and a different legal status. Ghana the same thing.
It’s something that we are seeing increasingly as an appealing solution to create much more transparency and clear organization between holding groups. So that there is no risk of co-mingling of assets and so mobile network operators that decide to enter the mobile financial services industry they have a subsidiary fully controlled. There’s a different corporate governance, a different board, different assets. Although it’s a subsidiary so it’s part of a group. I think that’s a very clean way to organize the business that give more comfort to the regulators. It’s a good example.
Whether that is the result of partnership between telecommunication authorities and central banks is less so. Because we are actually talking about a sub-class or a sub-category of a financial institution with very specific functionalities. So the telecommunication authorities here have a minor role because they just control the parent company and supervise the bank company which is not active in the delivery of the mobile money services directly.
One of the issues you’ve mentioned with the expansion of these new payment methods is adhering to know your customer regulations that these knew rails are not being used for money laundering or terrorist financing or things along those lines. I was wondering if you could talk a little about the action taken at the Financial Action Task Force. They have set a new regulatory framework for dealing with these new developments. And also beyond that, are there any other areas where you think it could be really beneficial for there to be some international cooperation?
Talking about the Financial Action Task Force, I think they’ve been very instrumental in changing the mindset of the standard setting bodies and providing more flexibilities. There’s been a long discussion in terms of whether the voice of the emerging markets have been heard by the standard setting bodies. And the fact that too often these organizations have been developing “one size fits all” type of regulations. We know that the reality of emerging markets in developing countries is different. The sophistication of the market is different. The characteristics, the legacy, the history of all the market is different. So it makes sense to try to reflect that reality in the way that standards are developed, adopted and implemented.
The issue that I’ve always seen is that there is a lot of pressure on the standard setting bodies, including Financial Action Task Force, to provide more clarity. At some point I’m a bit sympathetic with those organizations that needs to provide standards to more than a 190 jurisdictions. Because all of these standards are not binding, they become be the reference for the market and everybody in the end tends to apply those standards. I’m a bit sympathetic because there’s as much clarity that you can provide at some point. You cannot make a book of case studies where everybody tries to find their own situation and what is the solution to that situation. That relates to the capacity that is really needed at a local level to be able to interpret and implement those standards in an effective.
FATF has been instrumental because they have listened to the voice of the emerging market and understood the challenges that exist in a number of realities where it’s very difficult to identify people just because of a lack of a national identification system. There’s no proof of residence, particularly for people living in rural areas or for the nomads. There’s a number of people, farmers, that migrate from one land to another. So proof of access is a difficult thing. Some of these might have a number of significant assets, they are not necessarily poor. But they would never be able to open a bank account just because they don’t qualify traditionally. They don’t tick the boxes.
I think that the effort made by the Financial Action Task Force to start considering alternative ways to identify people. Such as a letter from the chief of the village, a voting card or an employment letter as a substitute so that we can a progressive tier system of KYC. So that you meet certain requirements and you limited functionality. The more you get into the system, the more you transact, the more money you put in your account, the more requirements you need to meet. I think that’s a very smart way to approach the problem rather than just saying “I need an ID card” when the ID card is not available.
The discussion on the standard setting bodies also link to the question of whether they coordinate with each other. So we know the importance of the Basel Committee for Credential Regulation. We know the importance of the Committee for Payment of Marketing Infrastructure, the CPMI for anything that relates to payment system. We know the importance of IADI, the International Association of Deposit Insurance. Regulators, they all play a role. Because we are talking about funds that need protecting and to be transferred. And entity that needs to catalyzed to be robust.
The question is whether the standard setting bodies talk to each other sufficiently. And they collaborate with one another sufficiently so that they avoid inconsistent provisions adopted in their respective silos. And so they do not create additional confusion in the market when the same regulators need to abide by different rules from different providers.
So one of the fundamental challenges of financial inclusion is you can give people access to a bank account. But if they don’t have any money or an income or any existing wealth, they can’t really conduct many financial transactions. You mentioned two billion unbanked around the world. I imagine a fair number of those people might fall in that category of people without a lot of money to transact. I’m wondering how you think about that aspect. Coming back to India, over two hundred million new accounts provided by financial inclusion program there over the last two years. Looking at the program that they have to link direct benefits transfers to these new accounts, is that a way to get people to start using these accounts? To give them some money that they are actually getting into that account to encourage activity. I’m just curious about that issue and how you grapple with it.
Certainly paying direct benefit transfers or social subsidies in a digital way directly into a mobile wallet or a bank account could be a solution. Or at least could be an initiative that will certainly help because there are a number of issues around those payments at the moment. They are inefficient and the amount that needs to be transferred doesn’t really reach the beneficiary. There is always risk of corruption, inefficiency, and the fact the final recipient doesn’t really receive what the person is entitled to get. So digitizing those payments and making sure that we use these databases so the government knows exactly who is supposed to receive what. We’re talking about food subsidies, energy subsidies, education and health subsidies. There are many programs that can be involved by digitizing those programs and by forcing these funds to be delivered into a mobile wallet or bank account. It should help because it automatically creates a bank account for each recipient. A household or an individual.
The question is how to capitalize on that initiative and make sure that the money is not cashed out immediately. Then we go back to our cash intensive economy and we actually create a digital liquidity that can be spent for education, food, for energy. So that liquidity stays in a digital form as long as possible. Which means we need to think about merchant acceptance. We need to think about processes that allow payments to be smooth and very fast and efficient. Competitive to paying cash, which is instant, immediate and anonymous. How do we make that experience digital so that it is compelling for the end user to transition from the cash experience into the digital experience?
So that sounds like an opportunity for fintech or other companies to improve those services to get people that maybe aren’t familiar with a digital transaction to see the light.
Certainly we are always looking for new solutions. Anything that can replicate experience that a consumer, us, ourselves, we have when we pay for anything in cash. The closer we get to that experience, the higher the probability for anyone to transition to a new payment solution.
If we start going through different steps, long menus, 16 steps to consult the balance or to make a payment, the connection is lost and then you need to start again. That is the first deterrent for anybody to use this product and services, and to continue to use them. There is also the question of word of mouth effect. If you are not happy with the experience you are not going to promote it to your friends and family. People will not trust the system and feel confident about whether their money will be safe. And so they won’t use it.
We talked a lot about the consumer angle in all this. But what about bringing small merchants into the financial system? How can fintech play a role in reaching out and bringing small merchants out of the grey economy and into the traditional economy? Is that an easy argument to make? Or is there some education and outreach that needs to happen?
It’s not necessarily an easy argument. This also relates to what I just mentioned in terms of the facility to complete a transaction. Certainly the merchant can play a role in order to keep that liquidity digital. Being able to receive funds from friends, from the government, from your employer in your wallet and then being able to spend or transfer or pay through that wallet in digital format is key. If that experience is not going to be easy and smooth it will be very difficult for the customer to use it. For the merchant there is a problem of visibility of all these transactions. We are dealing with a number of small kiosks, small booths and shops that just accept cash at the moment. Convincing them to transition from cash to digital payment solutions, we need to create the right incentive and the right argument so they are not scared by the prospect of paying more taxes. So they understand that the pie can be bigger, revenues can be bigger, efficiency can be bigger.
We realized that, for example, one of the selling arguments from organizations that are trying to promote this, is that advanced credit is much more interesting for the merchant than for other drivers. The fact that you can make your system more efficient, that you can have a better inventory, a better management of your business can allow you to have great advance in a much easier way. That can facilitate your business in terms of like rolling out the business on a daily basis. The merchant is certainly part of the equation in an ecosystem perspective, but it’s necessarily the panacea.
There are different schools of thought as to whether this is going to be a game changer. Whether this is really responding to the needs of the poor. Do they really need to spend digitally to buy a salad? Maybe there are other priorities, other needs that are much more compelling in terms of education and health. On the other hand it would be helpful in the long term, when we have addressed some of those priority issues, to allow more merchants to be part of the ecosystem in an efficient way so we can continue to keep that liquidity digital.
Sacha, thanks for joining us. We will keep an eye on your progress and wish you luck in your various financial inclusion efforts.
Thank you very much for having me.
We hope you enjoyed today’s conversation with Sacha. For more episode like this you can find us on iTunes, Google Play and Stitcher. For even more content look up our Pacific Exchange blog available at frbsf.org. Thanks for joining us.