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Fintech Ecosystem – the future of banking

Fintech Ecosystem – the future of banking

Digital’ has become one of the most commonly used buzzwords these days. Everything now has the precursor ‘digital’ attached to it, and digital banking is no exception. Digital banking means more than just going paperless. Banks are offering a new and improved customer experience and delivering faster and more efficient services. Banks are not known for being fast movers. Customers are still waiting for this new banking experience, which will bring many new features, including anytime and anywhere banking, ultra-fast response times, and ubiquitous advisors. The issue is not finding new digital solutions; the issue is the industry’s long-standing history of not keeping in shape.

The global pandemic may have brought the significance of digital banking platforms to the surface, but mobile and online banking aren’t new. The pandemic has merely accelerated a phenomenon that was already taking place. Digital banking offers a host of important benefits for consumers that can make their lives easier and make them better dispossessors of their money.

The definition of digital banking is simply the provision of service over the internet or through a digital medium. An example would be to transfer money to a mobile wallet as opposed to giving a cheque or cash or using an app to pay your utility bill as opposed to physically with cash. The real end result has to be a change in the customer journey. The customer must find the use of the digital medium convenient, secure and transparent but not necessarily less expensive.

Digital Banking in Pakistan

Digital banking has been operational in Pakistan for quite some time. However, the ongoing pandemic has played a pivotal role in further shifting the mindsets of our banking customers towards going digital. The findings from one of the first digital banking experience surveys in Pakistan- Banking in the Digital Age: Exploring Pakistan’s Potential, was conducted by A.F. Ferguson & Co, re-affirm the increasing customer inclination towards convenience & personalized banking made possible through digitization. The survey highlights that 82% percent of all consumers visit their physical bank branches once in a few months or only visited them once to open their accounts. Instead, 67% and 55% of the people prefer to use mobile and internet banking respectively to fulfill their banking needs.

Although Pakistan is mainly a cash-based economy, behaviors are changing and it cannot be denied that the future is digital. Mobile and internet penetration in Pakistan is growing exponentially – more than 83% of our population uses cellular phones and half of them (42%) are 3G/4G connection users. This shows a strong inclination of our masses towards digital services. Also, the government and other respective authorities are cognizant of this trend and have continuously introduced plans and ideas to facilitate the digital shift such as Raast, PayPak, and Roshan Digital Account to name a few.

Year 2020 and beyond has shown how the banking industry can respond to challenging situations with agility and innovative thinking.

However, there are some assumptions & theories revolve around SBP’s initiative for Digital Banking. The first and foremost is that if the State Bank of Pakistan (SBP) was to create a new category i.e. a digital bank license, a digital revolution would occur. In Pakistan, the payment services can be replicated by obtaining an EMI (electronic money institution) license. A lending license can be obtained through either the State Bank of Pakistan or the Securities and Exchange Commission of Pakistan. Therefore, it certainly cannot be concluded that the magic wand (digital bank license) would cause a digital financial revolution. The secondly with the increased payment transaction volume in the past six months, commercial banks will now lead the digital financial revolution. In reality, the most commercial banks in Pakistan have activities are similar to an asset management fund as opposed to a bank. The most profitable banks in Pakistan are heavily dependent on the interest rate arbitrage available between their cheap cost of funds and risk-free investment in government securities (Treasury Bills and Pakistan Investment Bonds). The notion that commercial bank branches will disappear due to digital progress flies against the realities of these branches being sources of cheap deposits. The commercial banks will continue to grow their physical footprint in order to protect their interest arbitrage. Thirdly the fintech will change customer behavior. Fintech (payments, savings, lending and wealth-management and information ecosystem) has seen healthy growth. Fintechs in Pakistan are legal entities, which are sound in terms of innovation but light on capital. While they may touch the tip of the iceberg, they cannot by themselves succeed to alter the customer behaviour in a country where cash is king. An estimated amount of Rs. 7.0 trillion is the cash in circulation outside the banking system.

To make digital banking a success, we need to take three major steps:

  1. Change must be viewed through the customers’ points of view. The biggest use case for cash substitution has to be digital purchases at the ‘retailors”.
  2. There has should be a wider partnership between commercial banks and Fintech. They both interface with each other, to have a better and flexible relationship to have a win-win scenario.
  3. The government must take the lead in creating a congenial environment where G2P and person-to-government payments becomes a norm of the day.
Electronic Money Institutions (EMIs):

In the year 2019, State Bank of Pakistan, with the objective to promote digital payments, foster innovation in payments industry, increase financial inclusion in the country and provide Regulatory framework to non-banking entities in payments landscape, issued Regulations for Electronic Money Institutions (EMIs) under the powers conferred on it by Payment Systems and Electronic Fund Transfers Act, 2007.
The Licensing and Regulatory Framework for Digital Banks unveiled by the State Bank of Pakistan (SBP) in January 2022 not only heralds a firm resolution by the central bank to shake up Pakistan’s banking industry, it does so while reinforcing its commitment to several objectives already being pursued, including the promotion of digital financial services, financial inclusion, and increased competitiveness in and innovation by the financial industry.

The EMIs are entities that offer innovative, user-friendly and cost effective low value digital payment instruments like wallets, prepaid cards, and contactless payment instruments. e-money has played a crucial role in digitizing different types of payments in various countries. The EMIs in Pakistan are expected to offer interoperable and secure digital payment products and services to end users.
Under the Regulations, Prospective EMI applicants are granted EMI license in three stages:

The first of the relevant aspects supporting these objectives includes the distinction between the two types of licenses: the Digital Retail Bank (DRB) license and the Digital Full Bank (DFB) license. While the DRB license may be viewed as a limiting option as it allows the incumbent to only service retail customer segments excluding corporate and commercial, with less than half the minimum capital requirement (MCR of PKR 4 billion) compared with what is required for commercial banks and the DFB license (MCR PKR 10 billion), it is a significant opportunity for license takers to focus on segments previously not catered to successfully by the financial and banking industry. Much like the MFI Ordinance which ring-fenced service provision to a particular client segment, this focus on niche segments, it is hoped, will propel license takers to break new ground in terms of customer segments, models and products and services. Experience in other countries demonstrates the ability of digital banks to penetrate certain segments more successfully than the incumbent banks—in the UK 18–21-year-olds constitute 26% of the customer age mix, compared to 12% for traditional banks; in India it is 31% compared to 7%. Similarly, Hello Bank by BNP Paribas, Ila Bank in Bahrain and TNEX in Vietnam have penetrated non-core client segments of banks including the youth, low-income individuals and Micro Small and Medium Enterprises (MSMEs). This is a vital consideration in Pakistan given that agri lending is 3-4%, SME financing is 6-7% and consumer loans 5-6% of overall private sector lending.

The second feature is the varied pool of sponsors eligible to apply independently and/or in collaboration for the license—local and international commercial banks, international digital financial services entities, microfinance banks (MFBs), and EMIs. In many countries like Singapore, Malaysia and Hong Kong, where the digital bank licenses were recently awarded, the applicant mix was extensive including banks, platform service providers, fintechs, telecom service providers, and even an airline company and a media house.

A third feature is the emphasis on a digital-only entity, with a requirement to phase out any smart branches within seven years of starting operations. This requirement will reduce the pressure on physical banking resulting in reducing the end price for consumers. It will encourage to use artificial intelligence and big data analysis, and customer support services. Currently, the average cost of customer acquisition and servicing for digital banks is 5-15% that of traditional banks. Developing digital-only entities in Pakistan’s banking industry are expected to yield benefits such as real-time updates, quicker account approval times, quick investing services.

By designing and developing the digital banks as a separate unit, these entities will forcefully adopt digital banking. While SBP issued the Branchless Banking Regulations in 2008, which have also undergone several iterations, and are now supported with additional regulations, guidelines and large infrastructure undertakings such as regulations for the digital onboarding of clients and merchants, cloud policy, and the instant retail payment system infrastructure, RAAST, digital transformation of the banking industry has fallen short of expectations. Even the microfinance industry continues to rely primarily on a physical model of outreach. In short, these entities will receive the focused attention and governance steer required to grow into Pakistan’s large market offering. The SBP is planning to award five digital bank licenses.

In the run up to the March 2022 deadline for applications, it is not yet certain what the split between DRB and DFB license awards will be. However, to ensure adherence to and maximize achievement of the underlying objectives stated in the framework, it is hoped the balance will be in favor of the DRB license.

Financial Inclusion

Financial Inclusion is considered a key enabler of economic development and is featured as a target in 8 of the 17 sustainable development goals (SDGs) of the United Nations (UN). Increasing evidence suggests that inclusion of small and medium enterprises (SMEs) and individuals can help increase economic growth, support job creation, aid the effectiveness of fiscal and monetary policy and contribute to financial stability. Research also suggests that the impact of digital financial inclusion of individuals alone can increase Pakistan’s GDP by $36 billion by 2025. To accelerate financial inclusion, Fintechs (or Financial Technology firms) are playing a key role. Through utilizing the power of digital innovation, Fintechs have been at the forefront of serving customers in disruptive methods, leading to increasing ease and convenience in accessing financial services for individuals and businesses alike.

Financial Technology (Fintechs) companies are revolutionizing the financial services industry throughout the world. By unlocking innovation, Fintechs are allowing the financial industry to serve customers in novel ways, enabling them to provide higher quality services at lower prices. In recognition of these innovative transformations, global Fintech Investments in 2020 were over $100 billion with almost 3,000 deals. Research also suggests that lockdowns, resulting from measures to curb the spread of COVID 19, have led to an increase in transaction volumes of fintech. Some important trends have emerged during the year of the pandemic, both on the supply and demand sides. These include accelerated digital adoption, shifting consumer behaviors towards digital platforms, and increased regulatory focus on the Fintech sector, amongst others. These trends are most likely to stay, and will define how Fintechs will continuous disrupt the financial services ecosystem.

Fintechs are at the forefront of enabling adoption and usage of digital financial services. The aspects related to regulations, infrastructure, investments, amongst others are required to come together to develop a conducive environment for the implementation of fintech.

The Future Fintech Ecosystem in Pakistan

Fintech holds abundant potential for Pakistan. The launch of the RAAST program, specifically, will most likely create a considerable market opportunity for Fintechs to capitalize on. A significant shift in adoption of digital financial technologies has also been observed on the demand side as a result of COVID 19. The volume of both mobile banking transactions and internet banking transactions has exponentially risen, by 102 percent and 42 percent respectively. Similarly, smartphone adoption doubled over the last two years, reaching 81 million by the end of 2019 (49% of mobile connections). It is anticipated to reach 70 percent by 2025. This shows a dramatic shift in consumer preference and a ripe market opportunity for fintechs to capture. The payments segment is most likely to see enhanced activity in the near future, followed by the infrastructure segment. The lending segment may also witness a rise in interest by fintechs.

[box type=”note” align=”” class=”” width=””]The author, Nazir Ahmed Shaikh, is a freelance columnist. He is an academician by profession and writes articles on diversified topics. Mr. Shaikh could be reached at[/box]

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