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Banks have to break away from legacy thinking

Not just for their own sakes.

According to the World Bank, an estimated two billion adults across the globe do not have a basic bank account. In addition, 200 000 formal micro-, small- and medium-sized enterprises in emerging economies do not have access to the financing they need to grow.

Effectively, these individuals and businesses are excluded from playing a more meaningful role in the economy. And, largely, this is simply because banks have found it too expensive to serve them.

“Banks have focused on the middle class in modern economies where people are making sufficient income to justify traditional bank branch infrastructure,” says Murray Gardiner, business director for inclusive finance at software provider Temenos. “Their cost structures are relatively high, so they’re accustomed to dealing with fewer numbers of higher value transactions.”

However, the majority of the world’s population lives in emerging markets where traditional banking infrastructure is poor and incomes are much lower. They represent higher volumes of low value transactions, which traditional banks have struggled to capture.

“To be able to engage with that type of client you have to be able to offer small loans, small savings accounts or micro insurance at a cost point that is profitable for the bank and justifies its delivery systems, and yet doesn’t present onerous transaction costs to the consumer,” Gardiner says.

This is both the greatest challenge and biggest opportunity that banks face.

It is a huge potential market for them, especially given that governments want to see more people participating in the formal economy. Technology is also providing the means to offer low-cost, accessible services on a large scale.

Beyond payments

However, banks face the serious risk of losing out to fintech companies that are leading the way in developing cheaper and more accessible ways to provide financial services.

Already mobile payments have become largely ubiquitous in many parts of Africa. M-Pesa in Kenya has been massively successful. The opportunity lies in offering the wider population similar levels of access to a full suite of services, and Gardiner believes it is important who is behind this delivery.

“Other services start to get to more complicated and costly, and require better understanding,” he explains. “If you are going to have meaningful financial inclusion and make any kind of real difference in terms of impacting the broad population you need to provide them with more comprehensive financial services.”

That includes the ability to invest, to save for retirement, and to access micro insurance and credit. However, that credit must be provided in a more sustainable way than it currently is through pay-day lending or bullet loans.

“A lot of fintech companies and alliances between banks and mobile network operators (MNOs) are targeting short-term, high-cost, micro credit and calling it financial inclusion,” says Gardiner. “But that tends to drive consumption rather than production or investment. That’s not necessarily a positive thing if you look at the level of indebtedness in countries like South Africa.”

In Kenya, the very successful alliance between Safaricom and the Commercial Bank of Africa has issued 86 million loans in the last four years. However, with the explosive growth of mobile fintech credit, some with APRs (annual percentage rates) of 600%, Kenya now has 2.7 million people blacklisted for non-payment, and 400 000 of those have been blacklisted for debt of $2 or less.

“That’s financial exclusion,” Gardiner argues. “For the working poor to work out how to expunge their credit record is very difficult and costly, so they then become excluded.”

Overcoming the legacy

Banks, he believes, are in a position to offer more comprehensive services to the poor and at far more reasonable rates.

“They have the scope and capacity that if they worked out how to drop transaction costs they could drive that usury out of the market and provide reasonable rates and services that help to uplift the majority,” says Gardiner. “I think this is where we have to be focusing with large banks that are interested in protecting their brands. They have a genuine interest in the community, and they can leverage off some useful fintech to reach the masses.”

What has hindered them is that they are tied to their own legacy systems.

“Banks have to break away from legacy costs and legacy systems, and use their footprints to drive products with a much lower cost infrastructure,” says Gardiner. “They cannot just repaint what they have or put a new front-end on old legacy systems because they will never be able to address prohibitive costs in that way.”

If banks do not do this themselves, they will lose business to pure fintech players who do. This is not just an issue for the banks themselves, but potentially for countries as a whole.

“If banks don’t use fintech now to introduce better and lower-cost alternatives that the poor can understand, relate to and get real value out of, they are going to lose those clients to niche players, who are often foreign, and have no interest in the national objectives of the country,” Gardiner argues. “If that drives issues like over-indebtedness, that’s of no concern to a foreign platform.

“If we allow such foreign platforms to undermine all the investment that’s been made over the last 20 or 30 years, and to break up that relationship between bank and client, we will all become dependent on foreign platforms and never be financially self-sufficient.”

Brought to you by Temenos.

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No. It’s not that we need smarter banks or more fintech to increase financial inclusion. Banks are gradually becoming irrelevant. Financial inclusion no longer depends on banks and financial services. Bitcoin may still seem like a novelty to those who aren’t close to it, but within the next few years every person under the sun can become their own ‘bank’ and many of today’s financial institutions will find their place in the history books.

Despite all the excitement of crypto-currency and the ‘Internet of Things’ the reality is there are 2 billion adults and 400 million SMMEs who do not have even simple access to a financial transaction account. People who do not even have access to potable water hardly are concerned about, nor even part of the world of Bitcoin.

Indigenous financial arrangements (savings clubs, ROSCA’s (etc)and local money lenders have been around since biblical times. Since the invention of money. If ideas at the bottom of the pyramid do not have access to financial liquidity in the form of debt or equity of some kind, there will be no economy for the poor. No path out of poverty. No long term political or economic stability for the modern sector either.

I think it is a little pre-mature to pronounce the death of banks. These are networks of real human relationships. People in communities organizing themselves with what little they have to survive and a bridge to the formal economy. Mass market retail financial institutions will change, but they will not go away as long as ordinary people need a connection to the market economy. There needs to be some form of financial inter-mediation to convert meager tangible forms of assets into financial assets which can be invested in local people and communities for provident and productive purposes to create a platform for growth. It will be a long time before every village hit or every shack has an Alexa or other robot managing their daily lives. There will be no completely cash free society ant time soon.

China, the most advanced fintech economy has hundreds of millions of peasants living has they have for millennia. So let’s not throw the baby out with the “fintech bathwater” and believe banks and baking is dead or irrelevant because 10% of the world can envision a Bitcoin future. Banks and banking have a critical role to play in the modern market economy but are threatened by a changing technology and business environment. Whats needed is a way to protect the financial institutional relationship that supports development and the wider economy.

Banks, community banks in particular, have relationship and that is a social investment that needs to be developed and extended to provide appropriate, quality essential financial services to the majority of people who have limited, poor or no formal economy financial engagement at all.

I think that any “Fintech Nirvana” is a long way off and will not be predictable based on today’s glimpse of the possible. As your investment adviser will tell you, the past is not necessarily a predictor of the future.

Regards,
Murray

Well the joke that is ABSA never will

Old school all the way

I’m not sure I’m entirely convinced by these arguments. I still have the following questions:
1. M-pesa has been tried in South Africa and other African countries, is there a significant reason why Kenya is the only country ever referenced?
2. Can the central bank not simply prevent any start-up that poses a threat to “national objectives” from forming?
3. Are FinTech companies not being absorbed by the traditional banks resulting in a decline in both the number of companies forming and the total investment dedicated to these companies?
4. What about the very important issue related to consumer trust and consumer safety. Will citizens, especially poorer ones, give their money to people using technologies they do not understand?

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