By Charles Augustine Abuka
I recently explored a number of ways in which technology is set to drastically change the financial sector in East Africa.
Today, I focus on a technological phenomenon, which is fundamentally changing the behaviours, needs and requirements of consumers today – ‘digitalisation’.
However, before discussing digitalisation, we need to have an understanding of what digitisation is and be able to distinguish it from digitalisation.
Digitisation is the process of converting, storing, transferring and processing information in a format understood by computers. Put simply; think about having a document written with pen and paper and then running it through a scanner in order to save it to your computer.
By scanning this document, you have digitised it and it can now be stored or used on any computer.
Digitalisation takes us to a new level of technological integration. Digitalisation is a social, economic and business transformation phenomenon, which is powered by technologies that we have at our disposal today.
The way in which governments, businesses and consumers adopt and incorporate these technologies is the essence of digitalisation – it enables you to seamlessly weave together processes, systems, customers, partners and employees and become the ultimate connected business. It is digitisation that enables digitalisation.
The Apple watch is an example of digitalisation at its best, where technology has taken an ordinary watch and transformed it into something with phone, messaging and Internet capabilities. The integration of mobile phone registration with the National ID database is another example of digitalisation at work.
In the financial sector, banks are running online Internet banking platforms, which offer a multitude of non-traditional bank services, including utilities and mobile phone services payments; banks are creating mobile wallets through which money transfers, deposits and withdrawals can be made in the palm of one’s hand; banks are even automating credit-making decisions (MoKash). There is an entire plethora of mobile money services currently being offered. All these are examples of digitalisation.
The optimists argue that digitalisation will impact economic growth positively; calling it ‘the second machine age’ and that it will ‘accelerate the rate of growth of innovations’.
The pessimists, on the other hand, say ‘the economy is unlikely to benefit from technological progress that is driven by digitalisation’. Indeed, the latter posit that ‘we have been waiting for accelerated growth for a long time now’. The impact of digitalisation on economic growth is still a subject of debate. However, signs of the potential impact of technology are starting to be visible.
For example, productivity growth derived from technological development could become the main driver of improved living standards in the long run and digitalisation is at the centre of bringing together these technological innovations to transform service delivery.
Let me focus on two major developments spurred by digitalisation. The first is mobile money, which is part of the broader financial services that also include mobile banking.
The mobile money platform enables the conversion of fiat currency so that it can be stored, accessed and transacted electronically. Mobile money can, therefore, be considered as an electronic wallet service, that lets users store, send and receive money using their mobile phone. Since its introduction in 2009, the user-base of mobile money services has grown and surpassed that of other forms of formal financial services, thus contributing to financial inclusion.
Finscope survey results of 2013 showed how the growth in the use of mobile money services largely contributed to the decline in the share of the population excluded from the use of financial services from 30 percent in 2009 to about 15 percent in 2013.
As at end September 2017, the number of mobile money customers stood at over 23 million from 1.4 million in September 2010. In addition, the number of transactions increased from 0.02 billion in the year to September 2010 to about 1.2 billion in the year to September 2017; while the value of these transactions rose significantly from sh0.7 trillion to over sh58.0 trillion over the same period. Mobile money agents remain the physical backbone and face of mobile money to digitise and disburse cash versus ATMs and banks.
As at the end of 2017, there were over 150,000 mobile money agents spread across the country from 23,153 at the start of 2013. Following the extensive agent growth, the number of customers per agent has dropped from 404 at the start of 2013 to 156 as at the end of September 2017.
A number of factors explain the growth of mobile money services. These include the fact that mobile network operators (MNOs), who are at the forefront of the mobile money platforms, were able to develop and deliver digital financial services with broader outreach in comparison to banks.
Another success factor is the high level of mobile phone penetration and the availability of relatively cheaper mobile phone sets on the market. Also, the increase in the number of mobile telecommunication companies has lowered the cost of mobile communication services.
Furthermore, an enabling regulatory environment also propelled the success as the support from the Government and the central bank provided the bedrock for scalable mobile money transfer services. Mobile money services have cost-effectively addressed two of the major challenges of financial inclusion - convenience and affordability.
My second area of focus is one that could stand to benefit us going forward, cross-border payments. The area of cross-border payments has benefitted and still stands to benefit from digitalisation.
The current landscape of cross-border payments still features multiple intermediaries and long-chains of operations (capturing, messaging, two-legged settlement and disbursement).
This makes transfers costly, cumbersome, slow and opaque. Innovations, such as distributed ledger technology (DLT), are, however, creating new and more efficient methods for making payments, which could change the current landscape for cross-border payments.
The DLT could be leveraged to enable users convert their domestic fiat money, using designated terminals (such as automated teller machines, websites or agents), into virtual currencies held in digital wallets. Then, the users can remit the virtual currencies over the virtual currencies’ secure networks – which seamlessly transcend borders – to their beneficiaries’ digital wallets.
The beneficiaries can subsequently redeem the virtual currencies as foreign fiat money. This would efficiently substitute the conventional payments, clearing and settlement process, which usually involves multiple intermediaries, including central banks and correspondent banks.
This development provides an opportunity to make cross-border payments faster, more traceable (transparent) and easier to use. It, however, still faces some challenges that need to be overcome.
In terms of the evolving regulatory environment around digitalisation, four key issues need to be kept in mind.
First, in this rapidly changing environment, authorities should be pro-technology, but remain technology neutral. Technology neutrality means that regulation designed to ensure consumer protection and financial stability should describe the result to be achieved, but should allow market players to adopt whatever technology is most appropriate to achieve the result.
Second, financial inclusion and access should be promoted – regulation will need to be flexible and broad-based to enable a balance between ensuring financial stability and fostering financial inclusion. Also, certain financial services are regarded as necessities and, therefore, access and inclusivity should be paramount. We know that digitalisation holds promise of better resilience through decentralisation, but this can also lead to increased vulnerabilities.
Preserving the stability and reliability of financial services should be one of the major priorities. As we have seen, the spectra of financial services is now offering digital financial solutions at a fast growing rate, particularly with mobile money. Its growth, outreach and interconnectivity with the financial system imply that its functionality could become paramount to financial stability.
The capacity of a regulator to deal with financial stability issues is, therefore, key to regulation of mobile money services and is an important reason why the global practice has seen Central Banks enter into Memoranda of Understanding (MoU) with regulators of MNOs. It is in this regard that the Bank of Uganda is already undertaking mobile money regulation.
The possibility of having a sole micro-finance regulator for mobile money would seem to understate its projected effect at the systemic level, as a new micro-finance regulator would suffer regulatory lag.
This would arise from the fact that whilst financial technology and digitalisation will continuously develop, evolve and attract demand within the financial system, the new regulator would have to initially build the capacity and frameworks for both microprudential supervision and macroprudential analysis, capacity that is already existent and has been developed for sometime at the central bank.
Third, while innovation will increase competition in provision of financial services, regulation must apply to all types of market players, banks or non-banks, to refrain from pushing the market towards a particular structure.
As a country’s mobile money market develops, attention should shift from facilitating investments to ensuring appropriate competition, aligning competition between banks and non - banks to enhance financial inclusion and making the regulatory frameworks of both sectors compatible.
Last, consumer protection, security and integrity – from a regulatory and supervisory perspective, consumer data protection and legitimate privacy should remain critical as a pre-condition for any financial services, especially given the vulnerability of customers and the common lack of financial education and awareness.
Trust and consumer confidence is fundamental to the successful adoption of financial innovations. Trust in digital financial services could come under threat from a number of challenges including agent fraud, system failure, weak data security and privacy, and questionable safety of customer funds, particularly where non-bank players may be involved.
The writer is the director, financial stability, Bank of Uganda