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This is a personal blog. Although the authors are affiliated with Coda Payments, the views expressed here are their own.


The appification of consumer finance

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In the bad old days, when you bought a smartphone (aka a Blackberry) or a PDA (aka a Palm), you were basically stuck with the software provided by the manufacturer of the device. Of course, there were ways of installing new programs, but it was a hassle and there weren’t many developers. All this started to change in July 2008, when Apple launched the App Store, which made it easy for users to download and in many cases buy—and, equally important, for developers to list and in many cases sell—applications. Today, apps are the dominant paradigm not just on smartphones, but also on tablets and increasingly on the desktop, too.

It occurs to me that the explosion of importance of apps is a useful metaphor for where I think we are headed in retail financial services, which I wrote about in my last post. In the bad old days, customers were reliant on their bank to provide a basket of most of the financial services that they wanted to consume. Of course, some banks offered services provided by other parties to their own customers (mutual funds and insurance products spring to mind as examples), akin to Palm licensing bits of software from other companies for its Pilot. But customers could either take the options their bank had curated or leave them. 

But I believe we are starting to see the contours of the next phase in consumer finance in which customers mix and match products offered by different providers, allowing them to arrange a suite of services that together meet their financial wants and needs. This in turn will allow, or force, providers of financial services to specialize in products that meet sometimes very specific requirements. And switching from the metaphorical to the literal, the user interface for many of these services will in fact be apps: see for example SocietyOne, a slick mobile-first P2P lending platform. What’s interesting is that this evolution is happening at the same time in both developed countries and in developing ones—or at least, those like Kenya where payment services are taking off. The operating system on which all these apps will run is the payment system, allowing customers to move their money between products as they wish.

If you think this metaphor is sound, then you may not be quite as dogmatic as many are about the need for payment services to be fully interoperable. We currently have two major incompatible app platforms in the world, with a few other also-rans, and it is the very fact that these ecosystems are in competition with each other that spurs customer-benefitting innovation. As such, this metaphor implies something different with respect to interoperability than does thinking of payment services as “rails” on which financial products can be delivered. Fragmentation (incompatibility or duplication) in rail networks is so costly that they are typically regarded as natural monopolies. Whether payment systems are, in whole or in part, natural monopolies is a question the answer to which I’m not too clear on.

In any case, appification will transform the way that financial products are delivered and consumed. It will upend the financial services industry and make tough new demands on financial regulators. But it will be an unmitigated boon for consumers.


Prising apart lending and deposit taking

An important theme on this blog is the disaggregation of the value chain in financial services. Usually what I mean by this is the separation of payments from the core banking services of deposit taking and lending. But perhaps even more interesting is the separation of deposit taking and lending themselves. 

Taking deposits and then on-lending them appear inseparable, but we don’t have to look very far for examples to show that they aren’t. In the developed world, a galaxy of specialized lenders such as credit card issuers and mortgage lenders focus squarely on the asset side of their balance sheets; in developing countries, many microfinance institutions work the same way. Without deposits, these entities fund their operations from equity or by borrowing wholesale in the capital markets. Conversely, there are banks like ING Direct that accept deposits but don’t make retail loans, and of course an increasing number of non-banks like Safaricom accept what walk and talk like deposits from customers. (If it weren’t for poorly thought through rules, some of these would even pay interest.) These entities aren’t allowed to on-lend those funds (for that would make them banks) or invest them in risk assets, so they park them in a regulated bank account instead.

In all these cases, financial intermediation—that is, the transformation of savings into capital that can be used by others for investment or consumption—doesn’t stop; rather, it occurs through new channels, facilitated by multiple institutions rather than one.

The separation of deposit taking and lending is good for consumers in part because it permits specialization. Surely one of the reasons that credit-card issuers like American Express and Capital One are good at what they do (and I mean good both in the sense that they offer products and services that customers like and in the sense that they do so quite profitably) is that they are focused on just on side of their balance sheet, whereas to excel as a bank, you have to win in two very different product lines.

If this is true for giant companies, it is especially so for startups, which can typically only hope to do one thing properly at a time. As such, the growing separation between lending and deposit taking is helping to make financial services more attractive to entrepreneurs. This in turn creates further value for consumers by exposing the retail banking sector to the kind of competition that more nimble upstarts bring to bear.

Technology (including but not limited to mobile technology) is an important catalyst for this divorce of lending and deposit taking. First, technology is making product innovation in both areas easier. In the UK, payday lender Wonga offers an ingenious design-your-own loan facility online; Zidisha is working on something conceptually related, but optimized for poor countries. On the deposit-taking side, M-PESA and its progeny are made possible by widespread mobile connectivity.

Second, technology makes it easier for customers to pick and choose financial services from different providers. A major enabler of the big retail banks’ “financial supermarket” strategy was the degree to which it was annoying for customers to open and maintain accounts at multiple institutions. Electronic channels (e.g., online and mobile banking) means that such “multi-homing” is much easier than it used to be. This in turn allows customers to use a wider range of financial instruments, offered by a larger number of institutions, to manage their financial lives.


Man vs. machine

One of the key innovations of M-PESA is shifting transactions—especially cash in and cash out—outside of expensive bank branches and into low-cost independent shops, or agents. (Ignacio Mas’s article “The Economics of Branchless Banking” remains the best overview of this; for real cost data, you can look here.) Over time, the use of agents has come to be understood as an essential component of branchless banking efforts.

Except when it isn’t. I remember being shocked when chatting with the then-General Manager of True Money in Thailand, who was brimming with excitement about the rollout of a network of cash-in kiosks. Surely, I asked, it would be cheaper to appoint agents, rather than investing in buying and then maintaining a network of expensive machines. But as we worked through the numbers, he convinced me that these kiosks would, in the long run, be a lower-cost channel than agents.

The reason why this was the case in Thailand, but wouldn’t be in, say, East Africa, is labor costs. In East Africa, you don’t have to pay agents very much in commissions to compensate them for labor. But where wages are higher—as they are in Thailand, a middle-income country—you do. In contrast, machines, which unlike labor are tradable, cost mostly the same everywhere, so using them for cash out and cash in becomes increasingly attractive the more expensive labor is. 

It turns out that Thailand is not an aberration; in a number of other middle-income countries there is a profusion not just of ATMs but also of machines that are capable of accepting cash. These machines are used by banks to collect deposits and by nonbank payment service providers to allow customers to pay bills, send money, and so on.

We can see this divergence very clearly in the numbers. The countries where agent networks have blossomed over the last decade—Tanzania, Uganda, Kenya, Rwanda, Pakistan, etc.—are all poor: Pakistan's GDP per capita in 2011 was $1,194 (expressed using exchange rates to US$ from 2000), and the rest had figures that were far lower. The countries where I've seen widespread use of machines for cash-in and cash-out—such as Russia, Thailand, and Malaysia—are far richer: Thailand, the poorest of this bunch, had a GDP per capita of $4,972, four times that of Pakistan.

This implies that it is only in low-wage/low-productivity counties where leveraging agents is going to be a game-changer. In middle-income countries, the labor-cost component will make it significantly harder to run agent networks profitably, suggesting that the burden of transforming cash into digital form and back again is likely to fall on networks of cash-in and cash-out kiosks, not agents.

The implication for banks and payment service providers trying to find new low-cost channels is pretty obvious: the wealthier the country, the less attractive agents, and the more attractive machines, become for cash acceptance and disbursal. Providers in middle-income countries will need to be creative when it comes to assigning responsibilities like account opening and customer education that agents can handle but kiosks can't.

I am less sure this point is clear to financial regulators. Of course, I am happy any time barriers that prevent institutions from leveraging agents as a transactional channel are torn down. But regulators in middle-income countries should be realistic about the role that agents will play in fostering financial inclusion. A number of middle-income countries made Maya Declaration commitments to boost financial inclusion through agents. Simple economics suggests they may be barking up the wrong tree.


Be careful what you advocate for

There is a little back-and-forth in the comments of a recent post by Elisabeth Rhyne on the Center for Financial Inclusion’s blog that exposes one of the most interesting fissures in the financial inclusion community today. As John Gitau frames it, “The whole inclusion space is divided into two—the apologists of the need to design products and services for the BOP at their terrain and as per their needs and those who advocate for inclusion to entail bringing the low income into the light, the light meaning formal financial services.”

Although tendentiously put, the tension is real. The emergence of M-PESA has prompted a rethink what financial inclusion really is, and not everyone has come to the same conclusion. I once wrote on the MMU blog that M-PESA “opened the eyes of many of us to the fact that payments are an important financial need” that could be met by nonbanks. But others have reacted more warily, coming to view payment services as a dangerous detour from the pathway to high-quality financial inclusion, which is understood to feature a bank account as its bedrock. (I am not the first to notice the irony in the fact that a number of those in the latter camp were themselves champions of microfinance in the days when it was the nontraditional upstart fighting for legitimacy in the world of financial inclusion.)

That a debate between these camps is taking place is a good thing. The problem is the way the debate is being refracted in policymaking. Unfortunately, it increasingly seems that the debate among financial inclusion specialists about what would be best has unduly influenced the debate among policymakers about what should be allowed. It is one thing to argue that the poor would be better off with one kind of financial service (a deposit account) than with another (an e-money account). But it is quite another to deprive them access to the latter as a way of encouraging them to adopt the former. I feel increasingly certain that, in a number of countries, mobile money is being suppressed not because regulators fear that it is unsafe but because they fear it will become popular—perhaps even used by some as a substitute for deposit accounts.

This is regulatory overreach. Financial regulators have a duty to ensure the stability of the financial system and the safety of services that are offered in it. If there are those in the financial inclusion community who believe that payment services offered by nonbanks are so dangerous that they fall into the category of products which governments may justifiably prohibit—I am thinking here of assault weapons and (to take a financial example) Ponzi schemes—then by all means let them say so. But if they rather view mobile money is akin to, say, Coca-Cola—not the healthiest choice, but not so damaging that it can justifiably be withheld from customers who want it—then I would encourage them to make themselves more clear on that point, and to be explicit that they do not want policy used as a tool for imposing their preferences on the poor.


The “too many mouths to feed” fallacy

Every so often I hear someone say something like this when talking about mobile financial services:

Developing a viable business model for mobile-enabled savings has also presented difficulty to stakeholders. Given regulatory constraints, bank-integrated mobile savings require cooperation between banks and mobile network operators (MNOs), and possibly other local agents to reach rural populations. A larger number of “mouths at the table” therefore reduces the surplus for all players involved, and may result in higher transaction fees or lower interest rates for end consumers.

This is one of the most elementary mistakes you can make in business or economics, but people make it all the time in the world of mobile financial services. To illustrate the absurdity of this line of thinking, imagine what the same logic would imply about, say, the car industry.

Car making requires cooperation between literally thousands of firms: steel mills who create the raw material, electronics specialists who wire up circuitry, and textile mills that fabricate the cloth for the seats. This large number of “mouths at the table” reduces the surplus for all players involved, and may result in higher prices for end consumers.

Obviously, the logic is exactly backward. Far from increasing costs, the disaggregation of supply chains reduces costs, because it allows firms to specialize. Apple sources components from several hundred suppliers (pdf), and it performs no manufacturing. I can assure you that, were it to instead vertically integrate and make all its iPads, iPods, and iMacs itself, those devices would be much more, not less, expensive. 

What we are seeing in financial services today is a much-needed disaggregation of the value chain for financial products in which nonbanks chip away at banks' vertical integration by competing in segments of the value chain, such as distribution, where they can operate more efficiently (pdf). In theory and in practice, this leads to lower prices for customers. The more mouths the better.