Business Daily (Nairobi)

Mbui Wagacha

7 December 2010

Since they crept into our moribund financial chess game, mobile money transfers have lowered the costs of distributing microfinance.

Embedded in the ICT revolution, the service has become a game-changer to a financial system dominated for decades by banks living comfortably on poor rewards to savers, rich pickings from government debt and hefty interest to private borrowers. This left a yawning spread, creating billions in annual profits for banks. The transfers have made virtually irreversible changes to the banks’ feast.

Writing in the Business Daily on January 29, 2010, I raised the red flag on high mobile tariffs. My argument was that they delayed, but could not scuttle an unstoppable game – that Internet Service Providers would embrace competition and that government revenues in the industry needed re-thinking in the public interest.

Subscribers applauded in ensuing e-mails. Mobile network operators (MNOs) penned unhappy and bad economics, grimacing at tariff cuts.

But the cuts came and, as predicted, favoured subscribers. They show government faces an uphill task if it does not re-think taxation and regulation in the industry. Cradled in an ICT-led economic revolution, we seem ill-prepared for change.

While the transfers champion adjustment, you won’t learn it from fretting banks and MNOs, whose mystical analyses conceal sharp knives out in a scramble for a market they neglected for years. As in the “Yes” or “No” vote in the recent constitutional referendum, Kenyans will win – nothing beats a person voting with their money.

Surprises await sceptics. A complex interplay of banks, consumers and MNOs will occur, again leaving subscribers smiling while the banks, operators and government may have to go back to the drawing board. Pointedly, ICT and the transfers will squeeze the role of banks in the financial market of Kenya’s “new” economy.

A gift to wananchi on the demand side, the giver of the transfers is Kenya’s world-beating MNOs that triggered the innovation on the supply side. The sector offered grassroots solutions to an age-old snub. Banks served the rich and gave a wide berth to potential customers in low-income groups and remote rural areas.

The poor put their money under the mattresses or buried it in their gardens. Their merry-go-rounds or chamas then dealt a mighty snub to banks. They swung an even bigger whack with mobile money transfers. This may end the mutual back-stabbing.

Welcome to poor people’s money and its effects on the future of Kenya’s financial sector. It poses interesting puzzles on strategy, economic theory and policy. Applauded the world over, the flows already are powerful drivers of Kenya’s economic growth and efficiency.

ICT applications and the cellphone, including the mobile money segment, grew on average by 23 per cent per year since 2000, accounting for 13 per cent of the decade’s GDP growth. It is creating Kenya’s “new” economy from the “old” one through enhanced efficiencies and new techniques of doing things. By this Christmas, the World Bank projects mobile money transfers will reach Sh560 billion ($7 billion) annually, equivalent to 20 per cent of GDP.

In developed economies, bond markets are the dominant segment in the financial sector, competing with banks by offering alternative sources of finance for investors and saving channels for savers through issuance, holdings and brisk secondary market trading of bonds. In contrast, banks are in charge in Kenya’s lucrative financial market as deposit takers and providers of lending.

In recent years, attempts to forge the alternative segment, a bond market, succeeded in diluting banks’ supremacy. But only slightly. The bond market is marginal and exhibits fiscal dominance, that is, the main purposes are public finances and the main issuer is government, despite recent forays by Safaricom and KenGen, among others.

Enter the mobile transfers, a third pillar of the evolving financial sector. Take the demand side. From 114,000 subscribers in 2000 the estimate for 2010 is more than 21 million subscribers, equivalent to the entire adult population.

Some 15 million holders of mobile sets – equivalent to 75 per cent of the adult population – apply them to money transfers. Mobile penetration (the percentage of the population using mobile phones) leapfrogged from 0.38 per cent in 2000. More than 90 per cent of all Kenyans above the age of 15 years had access to phone services in 2010. Falling call costs and wider coverage rake in poor peoples’ money to the mobile phone money market, and into the financial sector.

Checking risks

Unhappy, banks grumbled. After surprising debates in the Central Bank of Kenya (CBK) and the Treasury, with some clutching to “old economy” worries on money supply and inflation, in 2008 the Finance minister ordered assessment of the risks of mobile network operators providing money transfer services.

Early last year again, in response to qualms by banks, the ministry of Finance audited M-Pesa, Safaricom’s mobile money service. With banks gnashing their teeth at the competition, the transfers earned recognition as non-bank activities under the CBK Act, offering no interest and no loans to participants.

MNOs then forged in Kenya the floating electronic money called the e-float. For subscribers, this is perfect for remittances to rural households, payment of school fees and other household payments. The e-float is operated by an oligopoly of competing MNOs such as Safaricom, Airtel and YU.

While mobile money helps diversify the financial sector by further diluting the dominance of banks, the competition has induced banks to attempt to claw back lost ground in the deposit and revenue stakes from the lucrative poor man’s e-float held by MNOs.

With a possible squeeze on bank deposits by 2010, the financial institutions raised real interest rates to savers (actual rates minus expected inflation). Rates have edged towards positive territory for the first time since 1998.

As an example, note the collaboration of Equity Bank, targeting “middle of the pyramid” income earners to open savings accounts and M-Kesho accounts – a joint venture with Safaricom that allows phone users to earn interest on their mobile phone-based savings accounts. In early November, Equity moved shrewdly again to access Telkom Kenya’s national service network for use in the Orange mobile money transfers via agents it described in the media as “mini-Equity Banks”.

Price competition for the poor man’s e-float has thus taken two forms: the interest-free part that analysts call the transformational model, and the interest earning collaboration with banks, called the additive model, yielding interest to subscribers.

Expect banks to offer savers better rates to carve out a share of the e-float. On their part, MNOs compete not just with the banks for e-float, but are also in the trenches of a price war of their own to keep subscribers and their share of e-float. This comprises both the interest free accounts and the collaborative interest bearing accounts held for subscribers.

Every transfer from a subscriber in e-float earns them a handsome return from charges. Lose subscribers and you lose their e-float and, subsequently, the income from transfers. This part of the MNOs battle forms the competition for e-float shares aimed at locking in subscribers. Something must give.

Sure enough, a proxy battle has begun to woo subscribers with cuts in call tariffs in order to fend off migration to rival MNOs. Kenya’s call tariffs are now some of the lowest in the world, averaging Sh3 per minute in 2010, down from Sh16.8 per minute in 2002.

But battles like these leave casualties, even up the pecking order. A good example is the government. As ICT and mobile telephony graduate from exchanging e-float to exchanging goods and services (we could even see the Nairobi Stock Exchange trading on mobile phones soon), taxes will take a knock, both from falling call costs (remember the 26 per cent tax on mobile calls) and sales of goods and services. Taxes will inevitably be paid “in the air”, not to the Kenya Revenue Authority.

There will be poor data capture on economic activity, employment, prices and security. Sellers of fake, contraband and substandard goods and services may have a field day. Inflation figures may look funny: cutting calling costs lowers inflation, which CBK may applaud. However, government loses revenues.

Revenues dilemma

Moreover, despite growth, there are trade-offs in monetary policy: velocity of money, loss of control of money aggregates to tame inflation.

The above developments point to a tricky policy quagmire spawned by ICT and mobile money transfers. Government must grin and bear revenue loss, yet facilitate growth and regulation for the greater public good of economic activity, employment and a more inclusive and competitive financial system. With growth, it will certainly recoup larger revenues in the end.

Yet, there is much regulatory ground to cover. Let a sampling suffice: interest earned on deposited e-float owned by subscribers, who do not earn interest but whose accruals are used by MNOs for charities and foundations and threats from hackers who could break mobile security codes. But then, what change ever occurred without challenges?

Dr Wagacha is a macroeconomics consultant.

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