Expanding financial services for the poor:

1. IESE Business School Universidad de Navarra Expanding financial services for the poor: “Banking the unbanked using prepaid platforms and mobile phones (mobile banking)” Francesc Prior Sanz November, 2009

2. Banking the unbanked 1. Introduction: Access to finance and economic development 2. Review of access to financial services 3. Solutions proposed for increasing access to finance 4. Conclusions

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

4. Banking the unbanked 1- Introduction: Access to finance and economic development 2- Review of access to financial services 3. Solutions proposed for increasing access to finance 4. Conclusions

5. Review of access to financial services According to the World Bank (Beck, Demirgüç-Kunt, Levine, 1999), in the 24 most developed countries, the average credit to the private sector as a percentage of GDP was 84% between 1990 and 1999; while it was 33.6% in the 79 developing countries analyzed Table 1: Financial development by region, 1990-99- Interamerican Development Bank, IPES 2005.

6. Review of access to financial services The factors that explain the lack of access to financial services are related to the demand, regulation, and supply 1- Price SUPPLY OF FINANCIAL SERVICES: INADEQUATEBUSINESS MODEL 2- Distribution networks 3- Risk methodologies and database analysis 4- Regulatory framework 5- Lack of trust in the financial system and financial education

7. Review of access to financial services 1-Prices for basic financial services are higher in developing nations that in developed countries Table 2: Interest rates differences and efficiency by region, 1995-2002 , IPES 2005- Data from IMF and Bankscope

8. Review of access to financial services However, Prices for basic financial services do not refer not to only interest rates but also to: 1- Minimum balances Prices are too high mostly due to inefficient business models and lack of competition in the financial industry and a value management strategy 2- Maintenance costs of accounts, debit and credit cards 3- Transfer and withdrawal commissions 4- Other commissions 5- Interest rates

9. Review of access to financial services 2-Distribution networks are too limited because traditional banking branches are too costly, so alternative distribution networks are needed to serve the population Table 3: Density of bank branches and financial deepening: Based on data from Beck, Demirguc-Kunt y Martinez Pereira, 2006 Source: World Bank, 2005

10. Review of access to financial services 3-Credit risk analysis methodologies are not adapted to developing nations economies where informal activities 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 required in order to improve risk methodologies and obtain faster results

11. Review of access to financial services Credit risk methodologies: Credit bureaux are required in order to prevent over-indebtedness of individual lenders. However, they need to be complemented with additional methodologies as the US subprime crisis shows “Getting credit”. World Bank, 2006

12. Review of access to financial services 4-The regulatory framework can increase costs that affect the ability of financial institutions to offer financial 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

13. Review of access to financial services In sub-saharian Africa, a major regulatory effort has been undertaken where most countries have recently updated their regulatory framework for microfinance 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

14. Review of access to financial services Magreb: While the financial sector has been progressively deregulated, the microfinance sector is 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

15. Review of access to financial services In the USA 40 million American households are underbanked: Customer identification requirements and the retail payments structure are factors that help explain this 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

16. Review of access to financial services 2- The retail payments structure in the USA is characterized by the dominance of checks, and importance of offline debit Distribution of the number of Noncash Payments for 2003 and 2000. Federal Reserve Payments Study, 2004

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

18. Banking the unbanked 1- Introduction: Access to finance and economic development 2- Review of access to financial services 3. Solutions proposed for increasing access to finance 4. Conclusions

19. Solutions proposed for increasing access to finance The solutions proposed would apply existing best practices in low cost banking and the better use remittances 1- Specially tailored low cost financial products: prepaid instruments 2- Low cost distribution networks 3- Alternative risk methodologies 4- Optimization of remittances 5- Adapted regulatory framework and economies of scale are needed in order to be able to afford the infrastructures required

20. Solutions proposed for increasing access to finance 1- Prepaid instruments are the best electronic banking products for “banking the poor” since they function as a low cost bank account Types of card products based on authorization and authentication mechanisms

21. Solutions proposed for increasing access to finance 1- Prepaid instruments can be used for deposits (where regulation 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 cards 2-Users do not need to develop or invest in new technologies 3-This payment mechanism can be used in a number of platforms such as PCs, mobile phones, hand-held and set-top boxes 4-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.

22. Solutions proposed for increasing access to finance 2- LOW COST DISTRIBUTION NETWORKS are needed to resolve the lack of banking branches Cost comparison by distribution channel Mobile phones and EFTPOS are the lowest cost intermediation channels But in order to use them prepaid instruments are needed Source: Superintendencia de Bancos y Seguros del Perú 2006

23. Solutions proposed for increasing access to finance 3- ALTERNATIVE RISK ANALYSIS METHODOLOGIES must also use best practices in order to grant and follow up small credits Infrastructure and organizational changes 1- Inclusion of informal economy verified on the field (PROCREDIT) 2- Automated acquisition and behavioral scorings using socio demographic and payments information 3- Group based lending and village banking (COMPARTAMOS) 4- Decentralization of the credit risk analysis (ACCION INTERNATIONAL) 5- Use of Credit Bureaux

24. Solutions proposed for increasing access to finance 4- BANKING REMITTANCES flows and receivers will allow to exploit synergies between the banking and remittances industry Comparing the value chain of the banking and remittances industry shows potential savings in common elements such: The technology platform Risk analysis Financial services distribution network Call center and Internet Marketing and commercial campaigns POS network and SME business

25. Solutions proposed for increasing access to finance €200 Country of origin Recibo con No. confirmación Plataforma validadora Cliente Agencia emisora Terminal Intranet Corporativa No. confirmación Tesorería: Operaciones de divisas On line / Tiempo Real Agencia receptora en país de destino Banco o entidad asociada en país destino Cash €180 Beneficiario Recibo de la orden de pago en moneda local No. confirmación Cédula identidad o Pasaporte Punto de pago No. 1....”N” Country of destination

26. Solutions proposed for increasing access to finance 5- Adapting the regulatory framework to the needs of the 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)

27. Banking the unbanked 1. Introduction: Access to finance and economic development 2. Review of access to financial services 3. Solutions proposed for increasing access to finance 4. Conclusions

28. Conclusions Banking access in developing nations is very low due not only to demand and regulation, but mostly due to supply inefficiencies Supply side factors can be resolved using existing banking techniques and the optimization of remittances 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 methodologies 4- Banking remittances 5- Adapted regulation on e-money, agents and common platforms THE SOLUTION IS TECHNICALLY FEASIBLE AND FINANCIALLY SOUND

29. Conclusions Mobile banking is the most adapted value proposition for banking the poor using prepaid platforms and low cost distribution channels Classification of emerging m-banking models