It is early morning in Bukura, a small village in Western Kenya. The shop-keeper and his wife are preparing to open their small store, which sells household commodities such as flour and cooking oil. They also offer M-PESA services. There is already a queue outside. A group of about twenty villagers are crowding the entrance. “It is always like this,” the shop-keeper complains while pointing to the crowd. “Since we have become M-PESA agents we have no time to rest. This thing has even over-run our other business”. He then holds up a packet of sugar. “We have not sold any sugar in months. They only want M-PESA”. Not just the Bukura agent has seen a great demand for M-PESA services. Since its introduction in March of 2007, the M-PESA application has had great success all over Kenya. There are currently over 2.3 million registered users. Over 18 Billion Ksh had been moved through the system, via person-to-person transfers.

Some of the work that I have been doing makes several arguments as to why M-PESA has become so popular. Firstly, it is the young, male, urban migrants who are driving the uptake of services – customer adoption. These migrants are what innovation researchers call ‘early adopters’ of a technology. They are usually better educated and earn higher incomes than those in the village. Because these migrants are the senders, they can choose the channel for money transfer. They then influence recipients in the rural area—who are usually female, less educated and poorer—to also use M-PESA. This segment is referred to as the ‘technology laggards’. They are usually the last, and often the least likely, to adopt an innovation.

This research also notes some barriers to adoption. Both agents and customers complain of cash float problems, especially in the rural areas. Because the majority of transactions in the village are withdrawals, agents must maintain their cash float. They do this by making frequent trips to the bank. This can be problematic if the agent is not close to an urban centre, where most banks in Kenya are located. An agent in Malaha, a small village in Western Kenya, commented, “almost every day I ride my bicycle to Kakamega to top-up my float. This takes me almost three hours. I have to leave at 6am because I want to be there when the bank opens. I must then come back again and serve my customers”. When asked if there was any other means of transport to Kakamega, the agent shook his head. He said that he was several kilometres away from the main road. He also said that he could not afford to pay the 200 ksh fee for the matatu (shared taxi).

Despite these cash float problems, the majority of customers in both the urban and rural areas assert that they prefer M-PESA over other money transfer services. This means that M-PESA must be offering them some kind of substantial benefit. In Bukura, this benefit comes in the form of savings on transport. Customers do not need to travel into Kakamega, the nearest town, to access the service. One elderly farmer commented that “I can just walk from my shamba (farm) and get money. I don’t have to spend and go into town. If the agent does not have cash today, then I will come back tomorrow. It is cheaper to wait”. Finding strategies to manage the cash float problem will undoubtedly be one of the greatest challenges for Safaricom. For now, however, it seems like customers are willing to accept the inefficiencies of the service. It is, after all, cheaper to wait.

But if the POS is so good, why not go mobile? Especially in Kenya, home to M-PESA, an early pioneer in mobile payments and now topping 2 million registered users and 2500 agents across the country.

Jamii Bora seems ready. They have decent core banking software (Banker’s Realm), which should be able to handle a real time connection to Safaricom’s M-PESA platform for transaction processing and accounting. CGAP has said group lending may not always work with branchless banking. This seemed to be the case with Faulu, another MFI that worked with M-PESA when it first launched. But Jamii Bora has already gone to a system of groups nominating one member to carry in transactions. So there doesn’t seem to be a case that M-PESA will undercut the desire to attend group meetings, and through it the joint liability mechanism which deters delinquency.

In the end, M-PESA’s charges are too high to be economical for microfinance clients. So far, Safaricom has geared M-PESA’s fees to the remittance business. The KSh 30 (USD 0.48) it charges for a remittance up to KSh 2500 (USD 40.35) is quite reasonable compared to the post office’s PostaPay product, or even bus drivers who carry remittances. But microloan repayments are a different business, more similar to bill payments (set schedule, relatively small value of $5-10) than a money transfer (less frequent, larger amounts of $50 or more).

The average JB client makes a KSh 394 (USD 6.36) payment each week. If they used M-PESA to send in loan payments, it would cost KSh 600 (USD 9.69) over the life of an average 20 week loan. That’s equal to 69% of the interest paid on that loan! Another way to express the added cost is an increase to the interest rate paid: using M-PESA would be like raising the interest rate from 12.5% to 21% on the average Jamii Bora microbusiness loan. That’s costly.

But Safaricom might easily see a business case for slashing the fees it charges for bill payments, in order to bring in clients like microcredit borrowers, who will use M-PESA on a frequent basis. From the outside, it seems the average M-PESA client does 1-2 transactions per month. A Jamii Bora client would make at least 4 loan repayments per month. And once familiar with M-PESA, they may very well use it for other purposes.

Figuring out how to make M-PESA economical for MFI clients might deliver the kind of intensive user of whom Safaricom is in hot pursuit.

Kenya’s banking law and regulations look all too familiar: if an institution accepts deposits and uses this money for lending or investment, it needs to have a bank licence. And banks can only transact through their head office or branches. Full stop. But the Central Bank of Kenya has realized that operating through full-fledged branches, which are subject to detailed regulatory requirements, is a very expensive proposition. If the huge gap of banking services in remote and rural areas is ever to be closed, alternative delivery models will be required. Branchless banking models such as mobile phone banking (pioneered in Kenya by M-Pesa, which is run by a mobile network operator and not a bank) and the use of retail agents will be low-cost alternatives allowing for increased rural penetration. The Central Bank Governor, Prof Njuguna Ndung’u, has now pledged to institute necessary regulatory changes allowing banks to offer financial services outside bank branches.

If they want to convince central bankers that hold the keys to the payments space, mobile operators will make persuasive arguments about how mobile financial services meet traditional thinking about deposits, the new domain of payment system regulation, and the hot button issue of anti-money laundering, especially when sending money across borders.

No operator better illustrates this than Vodafone and its M-PESA money transfer service.

M-PESA’s commercial launch in Kenya required months of discussions with the Central Bank of Kenya about why M-PESA is more a payment service than a bank deposit. Once launched, the market responded with an excitement banks must marvel at: 1.8 million registered users in the first year (in a country with only 4 million bank accounts total). Central banks in other countries may be attracted by efficiency gains in the national payments system, but they won’t always be ready to allow mobile wallets if they are treated like deposits.

One solution may be payment system legislation that creates a licensing window for payment service providers that take funds from the public, but solely for the purpose of facilitating a payment or transfer. The EU’s Payment Service Directive will do just that, but much still has to be worked out by individual national governments before the November 2009 deadline. That means EU experience could become an important signpost to emerging market countries down the road. But it’s likely to be several years before a European track record emerges on carving out dedicated rules for firms in the payments business.

In the meantime, mobile operators may be better off pointing to countries that have crafted more ad hoc but, so far, very workable arrangements to oversee mobile financial services. In the Philippines, the central bank constructed accommodations allowing one mobile operator to offer a mobile wallet directly (Globe), and another model in which banks outsource the vast majority of functions to the operator (Smart). Both required some flexibility on the part of the regulator, as banking laws could easily have stood in the way. Together, Globe and Smart have over 7 million registered users for mobile financial services.

But the hurdles don’t stop here, as Vodafone seems to be finding out in switching on its UK-Kenya remittance service via M-PESA, according to this report. Moving money across borders immediately attracts concern about money laundering and terrorist financing. Vodafone is partnered with Citi, but it seems regulators still have questions about KYC. At the Kenya end, M-PESA customers open accounts via agents, who are neither employees of Citi or Safaricom, Vodafone’s Kenyan affiliate.

And that may be the one quick lesson for mobile operators: partnering with a bank may not automatically solve all your regulatory problems.

But the equation can radically change in emerging markets, making cash unduly expensive for financial service providers and clients alike.

Up to 70% of the 2000 ATMs installed in Pakistan are reportedly unable to dispense cash accurately. Pakistan’s has two Rs 1,000 notes in circulation, and the quality of the notes themselves can vary dramatically. As a result, ATMs routinely jam, or fail to accurately count notes dispensed. Branch-housed machines are repaired more quickly, but even there the error rate is reportedly 30%, according to a study by ShoreBank International. Consumers shy away from using ATMs, and banks’ investment in ATMs yields a diminished return, rather than cost savings they may have hoped for as customers are reluctant to give up the teller window for ATMs.

In Kenya, cash represents risk for ordinary people sending money home. Friends and bus companies are the preferred way to send money to family in other parts of the country, according to FinAccess, a nationwide survey of financial service behavior. However, Kenyans are quick to cite neither is perfect: money can too easily go “missing” with friends, and though bus companies are more reliable, the transit times are still long (often days). By contrast, clients of M-PESA, Safaricom’s mobile wallet service, say its cheaper for both them and their family, as there is often a Safaricom agent close by which will receive or dispense cash.

Cash can be costly for providers and clients alike. Moving transactions into electronic channels could make services more affordable to offer and use.

Mobile banking and other technologies need a balanced regulatory approach

Washington D.C. (January 31, 2008) – Basic, everyday financial services are out of reach for more than two billion people in developing countries. But the rapid growth of branchless banking – including mobile phone banking – is reducing the cost and expanding the availability of such services.

“All of this innovation presents challenges and opportunities for regulators,” says Elizabeth Littlefield, CEO of CGAP. “Policy will determine not only where branchless banking is allowed, but also which business models turn out to make economic sense - and how far they will go in reaching poor people.”

Regulating Transformational Branchless Banking is a product of collaboration between CGAP and the UK’s Department for International Development (DFID), in partnership with the GSM Association, the global trade association for over 700 mobile phone operators. The authors also benefited from conducting three of seven diagnostic missions with the World Bank’s Financial Markets Integrity Unit.

Download the Focus Note at http://www.cgap.org/policy/branchlessbanking

While much of the current buzz is around mobile phones, other branchless banking applications are gaining traction as well. Brazil’s increase in access to finance has been accomplished largely through the more than 95,000 banking “correspondents”—local merchants and post offices that act as agents for banks, equipped with card-swipe and barcode-reading point-of-sale (POS) terminals. In Russia, a broad network of bank ATMs, POS terminals, and online e-money providers offer transaction services outside of traditional branch offices.
In the past five years, technology has brought 13 million people in Brazil into the banking system. In the Philippines, people would rather pay one percent to remit money via their mobile phone network than the 3-18 percent they are often charged by others.

“The market is changing, and that creates an opportunity for regulators to adapt the rules to increase the availability of financial services for the poor while maintaining a safe and sound banking system,” says Catherine Martin, Team Leader of the Financial Sector Team at DFID. “The willingness to change is a good sign for poor people who need access to formal financial services.”

A new CGAP/DFID Focus Note addresses the policy implications of branchless banking. Regulating Transformational Branchless Banking: Mobile Phones and Other Technology to Increase Access to Finance is based on assessments of policy and regulation in seven key countries, including interviews with more than 500 people from governments, the private sector, and international organizations in Brazil, India, Kenya, Pakistan, the Philippines, Russia and South Africa. Read the full report and access country-by-country information at http://www.cgap.org/policy/branchlessbanking.

“For regulators, it’s not viable to simply do nothing. Current regulation tends to be both over- and under- protective,” says Tim Lyman, CGAP’s Senior Policy Adviser and co-author of the Focus Note. “Being too restrictive can mean fewer people in the formal financial system, and higher costs to access services. But policy makers also need to be aware of potential protection gaps.”

Among the countries studied, a surprising consensus surrounds the short list of most critical topics policy makers and regulators should address to formulate proportionate regulatory policy for transformational branchless banking. These include:

• Allowing third parties, such as local merchants to conduct “cash in/cash out” transactions and interact directly with customers;
• Risk-based anti-money laundering (AML) rules, as well as rules for combating the financing of terrorism (CFT) adapted to the realities of remote transactions conducted through agents;
• Appropriate regulatory space for the issuance of e-money and other stored-value instruments (particularly when issued by parties other than fully prudentially licensed and supervised banks);
• Effective consumer protection (on a variety of fronts);
• Inclusive payment system regulation and effective payment system oversight as branchless banking reaches scale;
• Policies governing competition among providers (which balance incentives for pioneers to get into the branchless banking business against the risk of establishing or reinforcing customer-unfriendly monopolies and which promote interoperability).

“In all these areas, regulators are best guided by balancing the costs and benefits against the objectives, a proportionate approach to regulation,” says David Porteous of Bankable Frontier Associates, who was commissioned by DFID as a co-author of the Focus Note.

For branchless banking to reach its potential, consumer protection is essential. Issues include problems with retail agents, redress of grievances, price transparency, and consumer data privacy. Regulators should aim for policy that fosters, rather than inhibits, innovation so market participants are not unduly restricted from launching new financial products and services.

“Based on our research, regulators should avoid limiting the range of possible branchless banking models. They should dialogue with industry, but the private sector ought to have answers on how they’ll ensure services are safe and sound,” says Mark Pickens, CGAP microfinance analyst and co-author of the Focus Note.

About CGAP
CGAP (the Consultative Group to Assist the Poor) is a consortium of 33 bilateral and multilateral development agencies and private foundations committed to building financial systems that work for the poor in developing countries. Headquartered in Washington, D.C., and housed at the World Bank, CGAP is a global resource center for the microfinance industry, setting standards, offering technical and advisory services, training, and information on best practices, in addition to providing funding for innovative projects. CGAP’s Technology Program, co-funded by the Bill and Melinda Gates Foundation, seeks technology approaches that help provide a variety of financial services to poor and excluded people, at large scale and in a viable way, within a regulatory system that encourages their development. For more information, please visit http://technology.cgap.org/.

About DFID
DFID, the Department for International Development, leads the British Government’s fight against world poverty. DFID supports long-term programs to help eliminate the underlying causes of poverty. DFID also responds to emergencies, both natural and man-made. Its work forms part of the global goal to attain the eight ‘Millennium Development Goals’ by 2015. DFID works directly in over 150 countries worldwide, with a budget of some £5.9 billion in 2006. For more information, please visit http://www.dfid.gov.uk.

But lost in all the buzz is the critical role third-party agents serve in the play for millions of low-income clients. A broad range of corner stores, petrol stations, lottery kiosks, post offices and other outlets feature prominently in the system architecture for such success stories as Safaricom’s M-PESA in Kenya, as well as in other countries, such as Globe Telecom’s GCash service in the Philippines.

Customers can sign-up for an account, deposit and withdraw funds via an agent. In fact, for mobile banking platforms run by mobile operators who don’t have a bank partner, agents may be the only way clients can sign up. No agents: no customer acquisition. And for mass market customers who want easy cash-in/cash-out, agents are the critical bridge from the electronic device to the cash economy they live in.

And finally, for managers having to show sizeable returns within a reasonable investment period, agents contribute to rapid scaling up in customers, transactions and cash-flow.

Consider this: M-PESA is about to hit 1 million registered users in less than 10 months operation. That amounts to a customer base one-third of the size of all of the clients of all of the banks in the country (approx. 3 million Kenyans have a bank account). M-PESA did it by building a network of 850 agent locations, which compares very favorably to the 550 bank branches in total. In the Philippines, GXI and Smart have over 5.5 million customers signed up, accessing service via more than 5000 agent outlets.

No doubt, customer uptake is measured by more than just sign-ups, and usage is a key driver for transaction-based fee revenue. Product design, ease of use on the mobile phone, marketing and other factors affect all this, but agents are a lynchpin in the business model for outfits like Safaricom and Globe aiming banking the unbanked.

China: Non-banking Institutions to Have Access to Small Payment System
China’s central bank People’s Bank of China (PBC) is going promulgate regulations on opening its small payment system to the non-banking institutions, said Xu Zhen, a director of PBC. The move shows PBC’s efforts to bring the small payment system into the competitive market. Detailed rules are expected to be released in 2008.

South Africa: Cell Phone Banking On the Rise
Cell phone banking in South Africa has more than doubled in one year and usage is to climb even more sharply in the coming year.  This is according to the Mobility 2007 study by technology research firm World Wide Worx. World Wide Worx’s latest study of mobile technology and commerce in South Africa, conducted in partnership with First National Bank (FNB), was released in Johannesburg on Tuesday.

MasterCard to tap ‘mobile’ data to widen reach
Mastercard is getting ready to tap the unbanked population in the country using the mobile phone customer base which has been seeing a rapid growth. The sharp domestic growth has made India a focal point for Mastercard, even as international banks like Standard Chartered, HSBC and Citi see it as a growth driver.

In the Philippines, another pioneer, Globe’s GCash mobile wallet, isn’t classified as banking either, but it is regulated by the central bank, unlike M-PESA (for now). What’s going on? Is there cause for concern? While Vodafone operates in a vaccum, the Philippines central bank crafted a special regulatory window that not only gives Globe’s GCash permission to operate, but gives the central bank the authority it needs to see mobile payments is safe for consumers and the financial system.

Kenya’s Banking Act [SEC. 2(1)] defines business as the acceptance of money from the public on deposit or on current account and the use of this money “by lending, investment or in any other manner for the account and at the risk of the person so employing the money.” Although M-PESA involves accepting repayable funds from the public, Safaricom structured the product in such a way that it falls outside the definition of “banking business.”

Funds collected from M-PESA account holders are held by M-PESA Trust Company Limited in a pooled account with the Commercial Bank of Africa. Interest earned on this pooled account does not accrue to or benefit Safaricom, and therefore M-PESA fulfils only the first half of the definition of banking (taking deposits) but not the second (employment of deposits to make money).

This is not necessarily cause for alarm. Vodafone has substantial reputational risk which tends to make it super careful about tainting its very profitable voice business. But what about a fly-by-night operator, which may be much less scrupulous and have far less to lose? Right now, Kenya does not have a national payment system law, and consequently CBK lacks the powers it wants to control entry into the mobile payments / banking space, require reporting and supervise for safety and soundness.

In the Philippines, the launch of GCash was also facilitated by the definition of banking in the General Banking Law [SEC. 3.1]. Banks are defined as “entities engaged in the lending of funds obtained in the form of deposits.” GCash involves a store of value for clients’ funds, but lending isn’t part of the service. Ergo, it’s not banking, like M-PESA.

But within a relatively short time span after the launch of GCash, the Philippines central bank crafted Circular 471, classifying Globe’s subsidiary, GXI, as a remittance agent. Rather than place the full weight of banking regulation on the GCash model, which may have been prohibitively expensive, the “remittance agent” category is sufficiently light, but crucially gives the central bank the ability to decide who can operate in the mobile payments space, engage with providers to understand their systems, request changes as necessary, and require reporting, so the central bank can actively monitor developments. Latest news from Kenya is the Payment System Bill will give CBK similar powers. However, the bill has yet to clear parliament and likely will not until the first or second quarter of next year, after Kenya’s election.