1 Expanding financial services for the poor: “Banking the unbanked using prepaid platforms and mobile phones (mobile banking)” IESE Business School Universidad

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Expanding financial servicesfor the poor:

“Banking the unbanked using prepaid platforms and mobile phones

(mobile banking)”

IESE Business SchoolUniversidad de Navarra

Francesc Prior Sanz November, 2009

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Banking the unbanked

1. Introduction: Access to finance and economic development

3. Solutions proposed for increasing access to finance

4. Conclusions

2. Review of access to financial services

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An extensive number of economic studies demonstrate An extensive number of economic studies demonstrate that there is a casual relationship between financial that there is a casual relationship between financial deepening and economic development (Schumpeter, deepening and economic development (Schumpeter, 1911)1911)

Access to finance and economic development

1- FIRST APPROACH: The impact of credit in economic growth has been extensively analyzed by King & Levine (1993) Demirguç-Kunt, and Loayza (2000) that show that credit is the explanatory variable in economic growth, especially in countries with underdeveloped capital markets

2-SECOND APPROACH: The development of capital markets is a second explanatory variable for economic growth analyzed by Levine & Zervos (1998), Levine (1991), Bencivenga & Smith (1991) and specially Rojas-Suarez & Weibrod (1994)

3-THIRD APPROACH: Explains economic growth not only in relation to the development of the banking sector, but also to its stability in the provision of financing as an explanatory variable on the levels of economic development: Freixas (1997), Rochet (1997), the Interamerican Development Bank (2005) and Garrido (2005)

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1- Introduction: Access to finance and economic development


4. Conclusions

2- Review of access to financial services

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According to the World Bank (Beck, Demirgüç-Kunt, Levine, 1999), in According to the World Bank (Beck, Demirgüç-Kunt, Levine, 1999), in the 24 most developed countries, the average credit to the private the 24 most developed countries, the average credit to the private sector as a percentage of GDP was 84% between 1990 and 1999; while sector as a percentage of GDP was 84% between 1990 and 1999; while it was 33.6% in the 79 developing countries analyzedit was 33.6% in the 79 developing countries analyzed

Review of access to financial services

RegionNumber of countries

Private sector credits (percent of

GDP)

Credit and market capitalization

(percent of GDP) GDP per capita,

1995 (US$)Developed countries 24 84 149 23.815East Asia and Pacific 10 72 150 2.867Middle East and Northern Africa 12 43 80 4.416Latin America and Caribbean 20 28 48 2.632Eastern Europe and Central Asia 18 26 38 2.430Sub-Saharan Africa 13 21 44 791Southern Asia 6 20 34 407

Table 1: Financial development by region, 1990-99- Interamerican Development Bank, IPES 2005.

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The factors that explain the lack of access to financial The factors that explain the lack of access to financial services are related to the demand, regulation, and services are related to the demand, regulation, and supply supply

1- Price1- Price

2- Distribution networks2- Distribution networks

3- Risk methodologies and database 3- Risk methodologies and database analysisanalysis

4- Regulatory framework4- Regulatory framework

SUPPLY OF FINANCIAL SERVICES: INADEQUATEBUSINESS MODEL

5- Lack of trust in the financial system and 5- Lack of trust in the financial system and financial educationfinancial education


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1-1-Prices Prices for basic financial services are higher in for basic financial services are higher in developing nations that in developed countriesdeveloping nations that in developed countries


RegionNumber of countries

Interest rate differences

(percentage)

Operational Costs (percentage of

assets)

Private sector credit (percentage

of GDP)Sub-Saharan Africa 32 10,6 5,1 15Eastern Europe and Central Asia 23 8,8 5 26Latin America and the Caribbean 26 8,5 4,8 37East Asia and Pacific 16 5,1 2,3 57Southern Asia 5 4,6 2,7 23Middle East and Northern Africa 13 4 1,8 38Developed countries 30 2,9 1,8 89

Table 2: Interest rates differences and efficiency by region, 1995-2002 , IPES 2005- Data from IMF and Bankscope

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However, However, Prices Prices for basic financial services do not for basic financial services do not refer not to only interest rates but also to:refer not to only interest rates but also to:

1- Minimum balances1- Minimum balances

2- Maintenance costs of accounts, debit 2- Maintenance costs of accounts, debit and credit cardsand credit cards

3- Transfer and withdrawal commissions3- Transfer and withdrawal commissions

4- Other commissions4- Other commissions

5- Interest rates5- Interest rates

Prices are too high mostly due to inefficient business models and lack of competition in the financial industry and a value management strategy


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2-2-Distribution networksDistribution networks are too limited because are too limited because traditional banking branches are too costly, so traditional banking branches are too costly, so alternative distribution networks are needed to serve alternative distribution networks are needed to serve the populationthe population

Source: World Bank, 2005

Geographic Area Number of

Countries

Bank branches per 100,000

people

Bank branches per 1000 KM2

Number of loans per 1000

people

Number of deposits per 1000 people

United States 1 30,86 9,81 N/A N/AWestern Europe 10 44,66 61,25 470 2.197Asia 10 8,13 18,57 110 715Eastern Europe 9 7,39 6,83 87 1.040Latam 17 7,02 5,20 120 490Africa 5 2,06 0,57 30 146

Table 3: Density of bank branches and financial deepening: Based on data from Beck, Demirguc-Kunt y Martinez Pereira, 2006


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3-3-Credit risk analysis methodologiesCredit risk analysis methodologies are not adapted to are not adapted to developing nations economies where informal developing nations economies where informal activities are so relevantactivities are so relevant

Only include stable and taxable cash flows (wages)

Do not include informal sources of revenue

Focus on already banked customers

Do not include socio-demographic variables

Are too slow and costly

Require guarantees not adapted to the informal economy

Credit Bureaus do not report non-banking credit experiences

Better use of technology and data is Better use of technology and data is required in order to improve risk required in order to improve risk methodologies and obtain faster resultsmethodologies and obtain faster results


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Credit risk methodologiesCredit risk methodologies: Credit bureaux are required in : Credit bureaux are required in order to prevent over-indebtedness of individual lenders. order to prevent over-indebtedness of individual lenders. However, they need to be complemented with additional However, they need to be complemented with additional methodologies as the US subprime crisis showsmethodologies as the US subprime crisis shows

RegionLegal Rights

Index

Credit Information

Index

Public registry

coverage (% adults)

Private bureau

coverage (% adults)

East Asia & Pacific 5.0 1.9 3.2 10.1Europe & Central Asia 5.5 2.9 1.7 9.4Latin America & Caribbean 4.5 3.4 7.0 27.9Middle East & North Africa 3.9 2.4 3.2 7.6OECD 6.3 5.0 8.4 60.8South Asia 3.8 1.8 0.1 1.3Sub- Saharan Africa 4.2 1.3 1.5 3.8

“Getting credit”. World Bank, 2006


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4-4-The regulatory frameworkThe regulatory framework can increase costs that can increase costs that affect the ability of financial institutions to offer affect the ability of financial institutions to offer financial services to the non affluent populationfinancial services to the non affluent population

Most common regulatory obstacles in Latin America are:

1- Price Caps

2- Taxes on transactions

3- Supervision Costs

4- Inadequate system of guarantees

5- Government forced investments in non profitable activities


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In sub-saharian AfricaIn sub-saharian Africa, a major regulatory effort has , a major regulatory effort has been undertaken where most countries have recently been undertaken where most countries have recently updated their regulatory framework for microfinance updated their regulatory framework for microfinance activities activities

•Kenya: Microfinance Act 2006

•Uganda: Microfinance Deposit Taking Institutions, 2003

•Tanzania: Microfinance Companies and microcredit activities 2005; Financial Cooperatives Societies Regulations 2005. Savings and Credit Cooperatives Regulations

However, since supply inefficiencies have not been solved there is a clear lack of microfinance supply in Sub Saharian -frica


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Magreb: Magreb: While the financial sector has been While the financial sector has been progressively deregulated, the microfinance sector is progressively deregulated, the microfinance sector is mostly state controlled and not adequately monitored mostly state controlled and not adequately monitored

• Tunisia: The microfinance law determines a price cap of 5% and gives the monopoly of microfinance activities to the government agency BTS, without providing adequate supervision

• Egypt: There is no specific regulation for microfinance activities. So banks and non regulated NGOs provide most microcredit.

• Morocco: The microcredit association law is a good framework for avoiding price caps, but their inability to collect deposits is a problem to solve

• Argelia: The postal service is the leading microfinance distributor (third party provider)

The postal service is the leading provider of microdeposits in all the region (French Colonial institution) , although the existing law prohibits this agency from granting credit


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In the USA 40 million American households are In the USA 40 million American households are underbankedunderbanked: Customer identification requirements and the : Customer identification requirements and the retail payments structure are factors that help explain this retail payments structure are factors that help explain this problem problem

1- Banking immigrants: Identification requirements for opening bank accounts are vague:

•No clear rule determines what documents are to be provided to comply with the “know your customer rule”•and nothing prevents non US citizens from opening accounts•and that the TIN is accepted by supervisors as an identification document•in the current political context, the fact that most illegal immigrants have TIN and not social security numbers makes banks unwilling to open bank accounts to customers without Social Security Numbers


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2- 2- The retail payments structure in the USA is The retail payments structure in the USA is characterized by the dominance of checks, and characterized by the dominance of checks, and importance of offline debitimportance of offline debit

Distribution of the number of Noncash Payments for 2003 and 2000. Federal Reserve Payments Study, 2004


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The still inadequate pricing of ACH transfersThe still inadequate pricing of ACH transfers (direct (direct debits and direct credits) compared with checks by the debits and direct credits) compared with checks by the Federal Reserve (the main ACH provider), Federal Reserve (the main ACH provider), and the late and the late differentiation of interchange for online debit and differentiation of interchange for online debit and offline debitoffline debit has negatively impacted the access to has negatively impacted the access to financial services by the poor in the USAfinancial services by the poor in the USA

1- The importance of checks has created a parallel network of financial services centers that offer not only check casing but also money transfers, bill payments, Earned Income Tax Credit declarations (EITC), short term credit (pay day lenders) even mortgages (subprime lenders)

•These financial centers offer much higher cost financial services but•Serve unbanked immigrants•US citizens that have been expelled from mainstream retail banking•And other customers that are not being served by the retail banking industry in the US

2- The late adoption of online debit in the US, created overdraft risks that banks did not want to take with unknown customers


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1- Introduction: Access to finance and economic development


4. Conclusions

2- Review of access to financial services

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The solutions proposed would apply The solutions proposed would apply existing best existing best practices in low cost bankingpractices in low cost banking and and the better use the better use remittancesremittances

1- Specially tailored low cost financial 1- Specially tailored low cost financial products: prepaid instrumentsproducts: prepaid instruments

2- Low cost distribution networks2- Low cost distribution networks

3- Alternative risk methodologies3- Alternative risk methodologies

5- Adapted regulatory framework and 5- Adapted regulatory framework and economies of scale are needed in order to economies of scale are needed in order to be able to afford the infrastructures be able to afford the infrastructures required required

4- Optimization of remittances4- Optimization of remittances

Solutions proposed for increasing access to finance

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1- 1- Prepaid instrumentsPrepaid instruments are the best electronic banking are the best electronic banking products for “banking the poor” since they function as products for “banking the poor” since they function as a low cost bank accounta low cost bank account

Types of card products based on authorization and authentication mechanisms

Credit

Bank account balance

Internal account Online Offline PIN based

Signature based

Prepaid Yes YesOnly if PIN based

If POS enabled, always in ATM's

If POS not enabled

Debit online Yes Yes

For very limited transaction amounts

If POS enabled, always in ATM's

If POS not enabled

Debit Offline Yes Yes

If POS enabled, always in ATM's Yes

Credit Yes Yes

If POS enabled, always in ATM's Yes


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1- 1- Prepaid instrumentsPrepaid instruments can be used for deposits (where can be used for deposits (where regulation allows), withdrawals and POS transactionsregulation allows), withdrawals and POS transactions

Prepaid platforms have characteristics that make them especially useful for developing low cost payments systems:

1-Customers using prepaid systems do not need bank accounts, debit or credit cards2-Users do not need to develop or invest in new technologies3-This payment mechanism can be used in a number of platforms such as PCs, mobile phones, hand-held and set-top boxes4-It is a payment system specially designed for micropayments, and microdeposits and even microcredits (Banco de Crédito del Perú, Tarjeta Solución Negocios)5-Allow users control their cash flow by receiving statements (some providers offer this feature online others provide physical statements) or accessing balances through PCs, mobile phones, hand-held and set-top boxes.


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2- 2- LOW COST DISTRIBUTION NETWORKSLOW COST DISTRIBUTION NETWORKS are needed to are needed to resolve the lack of banking branches resolve the lack of banking branches

Cost comparison by distribution channel

Point of intermediation

Financial ServicesEstimated Cost (Thousand US$)

Mobile phones0 for mobile

usersEFTPOS 20 USDRepresentative teller 5ATM 15Branch 200

Source: Superintendencia de Bancos y Seguros del Perú 2006

Mobile phones and EFTPOS are the lowest cost intermediation channels

But in order to use them prepaid instruments are needed


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3- 3- ALTERNATIVE RISK ANALYSIS METHODOLOGIESALTERNATIVE RISK ANALYSIS METHODOLOGIES must must also use best practices in order to grant and follow up also use best practices in order to grant and follow up small credits small credits

1- Inclusion of informal economy verified 1- Inclusion of informal economy verified on the field (PROCREDIT)on the field (PROCREDIT)

2- Automated acquisition and behavioral 2- Automated acquisition and behavioral scorings using socio demographic and scorings using socio demographic and payments informationpayments information

3- Group based lending and village 3- Group based lending and village banking (COMPARTAMOS)banking (COMPARTAMOS)

4- Decentralization of the credit risk 4- Decentralization of the credit risk analysis (ACCION INTERNATIONAL)analysis (ACCION INTERNATIONAL)

5- Use of Credit Bureaux5- Use of Credit Bureaux

Infrastructure and organizational changes


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Comparing the value chain of the banking and remittances industry shows potential savings in common elements such:

The technology platformThe technology platform

Risk analysisRisk analysis

Financial services distribution networkFinancial services distribution network

Call center and InternetCall center and Internet

Marketing and commercial campaignsMarketing and commercial campaigns

POS network and SME businessPOS network and SME business

4- 4- BANKING REMITTANCES BANKING REMITTANCES flows and receivers will flows and receivers will allow to exploit synergies between the banking and allow to exploit synergies between the banking and remittances industryremittances industry


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Recibo conNo.

confirmaciónCliente

Beneficiario

Recibo de laorden de pago en

moneda local

Agencia receptoraen país de destino

Punto de pago No. 1....”N”

No. confirmaciónCédula identidad o

Pasaporte

No.confirmación

Cash

Tesorería:Operaciones

dedivisas

Plataforma validadora

Banco o entidadasociada en país destino

On line / Tiempo Real

Agencia emisora

Terminal IntranetCorporativa

Country of Country of originorigin

Country of Country of destinationdestination

€200

€180


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5- Adapting the regulatory framework to the needs of 5- Adapting the regulatory framework to the needs of the poorthe poor


1- Support the development of prepaid instruments and low cost intermediation channels by developing e.money regulations that allow all basic payment functions on prepaid accounts from low cost intermediation channels

1- Development of e-money regulation:•Europe : The e-money Directive of 2000•USA: The emergence of the SVC industry under the MSB regulation

2-Development of agents regulation:•Review of banking correspondents regulation in Perú, Brazil and Colombia

2- Support the emergence of economies of scale for developing common platforms for Microfinance Institutions (Bansefi- Mexico)

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1. Introduction: Access to finance and economic development


4. Conclusions

2. Review of access to financial services

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Banking access in developing nations is very lowBanking access in developing nations is very low due due not only to demand and regulation, but not only to demand and regulation, but mostly due to mostly due to supply inefficienciessupply inefficiencies

Conclusions

1- Price of financial services

2- Density of banking networks

3- Credit risk methodologies

4- Non optimization of remittances

5- Regulatory framework

1- Prepaid instruments

2- Low cost distribution networks

3- Alternative credit risk analysis methodologies4- Banking remittances

5- Adapted regulation on e-money, agents and common platforms

Supply side factors can be resolved using existing Supply side factors can be resolved using existing banking techniques and the optimization of remittancesbanking techniques and the optimization of remittances

THE SOLUTION IS TECHNICALLY FEASIBLE AND FINANCIALLY SOUND

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Mobile bankingMobile banking is the most adapted value proposition is the most adapted value proposition for banking the poor using prepaid platforms and low for banking the poor using prepaid platforms and low cost distribution channelscost distribution channels

Conclusions

Model nameBank-centric models

Collaborative models

Independent service providers

Operator centric models

1-Who holds accounts/deposits? Bank Bank BankTelco/ Non bank

2-Whose brand is dominant? BankJoint- Non Bank or Telco

Usually non bank or telco dominant

Telco/ Non bank

3-Where can cash be accessed? Bank

Bank+ alternative agents

Bank+ alternative agent network

Telco network+ other

4-Who carries the payment instruction

Any telco (sometimes 3rd party payment gateway)

Usually specific to one telco

Usually many telcos

Specific to offering telco

Examples in developing nationsAdditive models Smart/ MTN Wizzit

Globe/ MPesa

Examples in developed nationsAdditive models Mobipay

PayPal Mobile/ Paybox NTT DoCoMo

Classification of emerging m-banking models

Documents

1 Expanding financial services for the poor: “Banking the unbanked using prepaid platforms and mobile phones (mobile banking)” IESE Business School Universidad