Monday, 15 September 2014

Commercial banking in Africa: The melting pot

Changing the way fortune is managed in Africa, might just change the fortunes of Africa.

In culinary terms, Africa is an exciting place. Variety is indeed the spice of life: from the fiery Ghanaian curries to bunny chow (food served in hollowed out bread) in South Africa. To a geek like me, financial innovation in the country is as exciting as the food - both have a rich mix of traditional and outside influences, of simplicity and complexity and of history and ingenuity.  

However, the most exciting thing about this innovation is that it's a recipe for growth. Banking is the cornerstone of a functioning economy. It provides liquidity and security, supporting both the growth of business as well as the financial security of citizens. 

It is thus dispiriting to read that Africa is one of the least ‘banked’ places in the world. The level of banking penetration (the proportion of people with bank accounts) is only 16.6% in Sub-Saharan Africa, compared with a global average rate of 63.5%. This is partly because of a lack of infrastructure (there are only 5.8 branches per 100,000 people in Nigeria). However low levels of income across sub-Saharan Africa also play a role, as banks have few incentives to attract savers with the likelihood of only ever saving small amounts. Indeed at many banks, the minimum required deposit can be as high as a person’s average annual wage. There is also reluctance by banks to locate in places where political and economic environments can be volatile. It was only a court injunction that prevented Barclays from cutting all banking services in Somalia recently, due to concerns over exposure to money laundering in the fragile state. 

But despite economic, political and structural challenges, the bottom billion is rising and the opportunity to attract first time customers is just too good to forgo. Thus a variety of actors are stepping into the breach, with new and innovative ways of providing financial services to poor Sub-Saharan Africa. The ingredients are a surprising mix, but could, in the right amounts and with good timing, send African GDP climbing. 

The ingredients for a newly banked Africa: 
  • Loans and savings:
    • Innovative saving schemes 
    • Micro finance
  • Transfer of money:
    • Cheaper and quicker domestic money transfer systems  
    • Cheaper and quicker cross-border money transfer systems
  • New types of money not subject to  state governments
    • Virtual currencies
So let's start with those traditional ingredients we take for granted in our own long established banking sector; the ability to save and take out loans. 

Providing innovative ways of saving has the ability to transform the business environment and home life for many Africans. Without bank accounts many people in sub-Saharan Africa are left without the opportunity to save for the future - to even out income streams or save enough capital to start or scale an enterprise. Instead they are entirely dependent on their daily income.

Yet, innovative schemes are negating the need for a traditional banking infrastructure. Let's start by looking at the now famous micro-finance movement. The precise origins of the schemes are unclear but it is most commonly attributed to Muhammad Yunus who set up the now largest microfinance institution, Grameen Bank, in Bangladesh.  Yunus had discovered that the poor often remain poor because of lack of access to credit or savings. Lack of access to small amounts of capital meant that when a crisis occurred such as the ill health of a wage earner, a family could not tide itself over with a loan. Equally, many micro-businesses, which operate primarily in the informal sector, often have no access to credit; either through a lack of financial know-how or because they are sitting on what Hernando de Soto described as 'dead capital'. This phenomenon occurs when, activities in the informal sector are denied loans as the capital they have is not legally securable. Therefore it cannot be used to help guarantee a loan. By making tiny loans to those living in poverty across the globe, microfinance institutions can help avoid people falling back into catastrophic poverty and deprivation as well as giving them opportunity to secure a better livelihood through entrepreneurship.

Innovations in micro-finance schemes have also lead to micro-saving schemes. These occur at the community level in the form of a saving and loans association. Similar to a regular bank, 25 to 30 members pay in small amounts of money which are then pooled and lent to individual members over a 6 to 12 month period. Interest payments form the returns to those in the association. These schemes have proved to be popular across the developing world they have 4.6 million users across 54 countries.

However banks exist not solely to provide loans and savings. They also provide other crucial services such as the transfer of money between accounts and providing hard currency, allowing account holders to securely pay bills or transfer money to friends and family. Both security and liquidity are the key ingredients provided by banks here. Traditionally this has required expensive infrastructure and willingness by financial institutions to invest in a country. 

But African entrepreneurs are finding ways around this by using technology to leapfrog traditional barriers and in the process often enhancing the technology they originally absorbed. A classic example, and the next ingredient in this recipe, is the mobile money transfer system, M-Pesa. Developed in Kenya by Vodafone's local service provider Safaricom with advice from the UK's Department for International Development, the system allows Kenyans, Tanzanians and more recently South Africans to transfer funds through their mobile phones. They can also use the service to withdraw money for a small fee. This simple technology has radicalised finance in Africa driving better financial management by individuals and an increased rate of business activity.  The charitable network CGAP found that M-Pesa increased the incomes of rural recipients by 5-30%. It has also increased security by negating the need for users to carry cash. 

This tasty ingredient could be further complemented by a superior international financial transfer system. Let's go back to Barclays attempting to cut off financial ties with Somalia. This would have been a disaster for the country, which is dependent on remittances (money being sent to the country by Somalis working abroad). Fully 40% of Somali families rely on these to meet their most basic needs, such as food and healthcare, according to Oxfam. And Somalia is not an anomaly in Africa, remittances comprise 25% of Liberia and Lesotho's GDP and 38% of Eritrea’s.

The challenge with international transfers is that moving money across borders can be expensive. Africans sending money home, using transfer services like Western Union and MoneyGram, lose an average 12.4% in fees. Within Africa it can be even worse; it costs an average of 22% to transfer money between Tanzania and Kenya, the homes of M-Pesa. These high fees are largely due to a lack of competitors and high regulatory hurdles. 

How to prevent Africans losing 12.4% of the $60 billion they send home every year? A company called Earth Port might be the answer. It is not a small start-up or a charitable endeavour, but since 1998 it has worked to become a global aggregator of local payment systems. Instead of navigating the numerous electronic banking systems it moves money on its own platform called universal payments systems. In this way it provides low cost international transfers to over 60 countries and its reach continues to expand. Its clients include smaller online transfer systems like Azimo to the major players such as Barclays and Bank of America. Earth Port promises to halve the cost of remittances compared to traditional wire payments. If adopted across Africa, this could have enormous financial benefits. A 2013 World Bank study found that if, remittances fees fell in Africa by just over half, to 5%,  then this would return $4 billion into Africans pockets. Earth Port’s innovative technology might just be a way of achieving this.

The final and most experimental ingredient in this recipe is digital currency, which has the potential to be the most transformative in Africa's financial system. I'm going to use the most infamous example of virtual money, Bitcoin, but it's possible to look to other varieties too. Bitcoin is a decentralized, software based, digital currency that uses peer-to-peer technology to facilitate instant payments, mostly to purchase goods and services.  The media has tended to focus on Bitcoin’s more nefarious uses, particularly its use to launder money and to pay for illegal substances, most famously on the Dark net marketplace, Silk Road. Yet, the features which make it such a bugbear to governments and central banks could actually bolster trade and investment in Africa. 

To begin with, digital currency might make the transfer of money faster and cheaper than any remittances service ever could. Bitcoin operates outside the traditional financial system and by cutting out banks as middlemen, it could greatly reduce the cost and speed of moving money in Africa. Moving Bitcoin is virtually free and transfers would be near instant - the current remittances process can take up to 5 days. E-commerce in Africa would particularly benefit from the wider use of virtual currency. Merchants currently struggle with global online payments as credit cards place high transaction fees on payments to Africa and fraud issues are a constant worry. 

However, the most appealing feature of virtual currency as an ingredient is that its stability does not rely on the stability of a national government. This might seem a strange point to some. How could Bitcoin, whose price volatility is 10 times that of the US dollar, and whose value dropped by nearly a third after the crash of the Bitcoin exchange Mt. Gox, be more stable than a national currency? It's important to remember that Bitcoin is relatively new and the first of its kind to achieve significant market attention. As Bitcoin and other virtually currency's expand they should naturally trend towards stability as confidence in them grows. Consumers were wary of trusting online payments such as PayPal in their early days. However a growing number of users and a proven safety record created a virtuous circle of growth and trust and PayPal was, until February, the largest online payment system. Increased liquidity will also lend stability to Bitcoin. It stands to reason that with more Bitcoins and money behind them, a single incident or player, is less able to disrupt the market. Governments also creating a fixed regulatory policy around virtual currency would also lessen much recent uncertainty

Thus an increasingly stable ingredient might be the key for many African countries where their own local currency is often very unstable. One only needs to think of the instability experienced by Zimbabwe under Mugabe, where inflation reached 79.6 billion % before the currency was abandoned entirely.  Even Ghana, a bastion of new growth and development in Africa, has seen its currency slide by around 40% this year. Bitcoin, which doesn't rely on a central bank and is relatively free from political meddling, could provide Africans with a currency they can trust. Indeed a company, BitPagos, is focused on trying to create a Bitcoin ecosystem in Latin America, where individuals in countries with high inflation such as Argentina and Venezuela, can rely permanently on Bitcoins, instead of switching into national currencies. 

Virtual currencies are not a perfect answer to unstable economies in the emerging world. There are of course risks that Bitcoin's anonymity will attract money laundering and finance terrorism in Africa, thriving on, instead of helping solve, instability. Yet the world’s most stable national financial institutions often developed over hundred year periods - in a country that is increasingly using technology to leap frog so many traditional development problems, currency should be no exception. 

So there we have it, a rich mix of innovation, coming together to ‘bank’ Africa. It’s inspiring to see a continent, where 600 million still lack access to enough electricity to light their homes, at the cutting edge of financial innovation in so many ways. From local village groups to global online payments systems, finance is driving development and equality across Africa. That’s what I’d call a recipe for success! 
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