Microfinance and Mobile Banking Regulatory and Supervision Issues

Anwar Ammar

Faculty of Management Multimedia University, Cyberjaya, Malaysia

Elsadig Musa Ahmed

Faculty of Business, Multimedia University, 75450, Melaka, Malaysia

E-mails: (anwar_ammar@yahoo.com, elsadigmusa@yahoo.com)

AbstractMobile banking is growing at a remarkable speed around the globe. Mobile banking can increase poor people’s access to financial services if regulation (i) permits the use of a wide range of agents outside bank branches, thereby increasing the number of service points, (ii) eases account opening (both on-site and remotely) while maintaining adequate security standards and (iii) permits a range of players to provide payment services and issue e-money (or other similar stored-value instruments), thereby enabling innovation from market actors with motivation to do so. This paper looks at these issues within the regulation of mobile banking. Since it lies at the interface between financial services and telecoms, mobile banking also raises competition policy and interoperability issues that are discussed in the paper.

Keywords: regulatory, supervision, microfinance, telecoms, mobile banking

1. INTRODUCTION

Evolution takes place slowly and incrementally. Ideas in one field get transferred to other fields. Unmet needs lead to new innovations and these create new economic relationships. New modifications and new mixtures take place with apparently disparate partners creating a need for other institutional adaptations. Such a fusion is now occurring between the banking industry and the telecommunication industry, creating a new notion called mobile banking. This sector is being constrained by the slower development of regulatory framework owing to conservatism and loss aversion.

One such unmet need is to provide financial services to 77% of the world’s poor currently unbanked. Specifically looking at East Asia and the Pacific, only 55% of adults have an account at a formal institution. For a country’s economy, limiting banking activity to traditional approaches can stifle entrepreneurship, stunt development and even stall economic growth through the effective exclusion of large numbers of potential banking customers. Microfinance- providing affordable financial services to the poor - is one way to meet the financial needs of those languishing.

According to the Consultative Group to Assist the Poor (CGAP), “poor people with access to savings, credit, insurance, and other financial services, are more resilient and better able to cope with the everyday crises they face. Even the most rigorous econometric studies have proven that microfinance can smooth consumption levels and significantly reduce the need to sell assets to meet basic needs. With access to micro insurance, poor people can cope with sudden increased expenses associated with death, serious illness, and loss of assets.”

On the 10th September 2008, instead of carrying cash to his weekly meeting, Mohammad Githio Yunus used his mobile phone to repay his microfinance loan. Although not the same Mohammad Yunus who fathered microfinance, he too is a pioneer: the mobile technology he used has the potential to revolutionise the microfinance industry around the world. Mohammad is one of many Kenyan individuals benefitting from a partnership between Small and Micro Enterprise Program (SMEP), a large Kenyan microfinance institution (MFI), and Safaricom, Kenya’s largest mobile operator and Vodafone partner. (TJAS).

The successful adoption of innovations in delivering a complete range of financial services to the unbanked/under banked necessitate not just modifications in financial regulation and supervision, but also the development of new legal, policy and regulatory frameworks that these new delivery modes will require to effectively protect the interests of clients, including their privacy. It will entail efforts to ensure the legal transparency and predictability required to attract financial service providers into the market, and to ensure the financial stability and efficiency of the overall economy. It will entail the development of new methods of financial education and financial capability building, especially for vulnerable low-income population groups. Innovations will also have an impact on the development of the market infrastructure supporting the delivery of financial services, particularly payment and settlement systems, remittances and credit reporting. These innovations are expected to eventually benefit all in the process of financial inclusion. (Asia-Pacific Forum 2013)

2. Microfinance

Modern microfinance was born in Bangladesh in the 1970s, in the aftermath of the country’s war of independence, when Muhammad Yunus, began an experimental research project providing credit to the rural poor. Over the years microfinance industry has grown exponentially, in terms of the number of clients as well as the number and type of providers and products. The focus is no longer only on credit for investment in microenterprises: Today there is broad awareness that poor people have many and diverse financial service needs, which are typically met by a variety of providers through multiple financial services. Over the years, the discourse has shifted from “microcredit” to “microfinance,” and now widespread concern for “financial inclusion” is directing attention to the broader “financial ecosystem” and how to make financial markets work better for the poor.

A World Bank study has identified three objectives of MFIs that are very often cited (Webster, Riopelle, &Chidzero, 1996): 1) to create employment and income opportunities through the creation and expansion of micro-enterprises, 2) to increase the productivity and incomes of vulnerable groups especially women and the poor, and 3) to reduce rural families’ dependence on drought-prone crops through diversification of their income generating activities.

Over the past decade, microfinance institutions MFIs have become an important component of the broader financial sector in many countries. No longer is microfinance the domains of small NGOs that stand apart from the financial sector – increasingly, banks are competing with MFIs, while many MFIs have become banks themselves. Microfinance institutions provide a variety of financial services designed for poor clients like (savings products, microcredit, payment services, micro leasing remittances and micro insurance etc.) and has emerged an important tool with the use of new technology, policy reforms and financial innovation across the world.

Financial Access 2010 reviews that survey responses from 142 economies and updates statistics on the use of financial services found that many nonbank institutions also provide financial services and some even have specific financial inclusion mandates. These include cooperatives, specialized state financial institutions, and microfinance institutions. In a number of West African countries—Benin, Burkina Faso, Côte d’Ivoire, and Niger deposit-taking microfinance institutions have more depositors than do commercial banks, which suggests that nonbanks can be an important player in providing basic deposit services.

Although some debate exists, microfinance can be a powerful way to fight poverty and promote economic development (e.g., Littlefield et al. 2003; Goldberg2005). Each type of microfinance service can deliver social and economic benefits. Payment services allow poor households and small businesses to transfer money in a faster, safer, and easier way than cash payments. Not only do the payment services create a platform for households and small businesses to forge a formal relationship with microfinance institutions, but they also help clients build a credit history, which is critical to further utilization of financial institutions. Loan services increase household income and can provide people with better living conditions, health care, and education. Loans can also help build household assets by enabling business investments that can generate returns. Savings and insurance services help households better manage cash flow and protect them from unexpected financial hardships. Just the knowledge that these services are available can provide peace of mind, which may help people make better decisions in the long run (CGAP Impact).

3. Mobile Banking And Microfinance

Mobile banking (m-banking) is a subset of branchless banking and involves access to a range of banking services through mobile telephony. One of its main advantages is that it addresses the cost of roll-out (outreach) and the cost of handling low-value transactions by using agents instead of banks. M-banking channels are primarily used for transfers and payments, even when they offer a broader range of services.

The recent success in mobile banking can be attributed to the microfinance movement in its early inception. The Kenyan narrative with M-PESA serves as the origination of mobile banking for the delivery of microfinance. In 2005, M-PESA was designed as a pilot project to facilitate microfinance payments for Faulu, a microfinance institution (Kumar, McKay, and Rotman (2010). However, due to technical and structural challenges in its early stages, the mobile banking uptake failed (IFC, 2010). Safaricom, the mobile network operator, observed customer usage patterns and determined that customers were creatively changing the course of mobile banking (Kumar, McKay, and Rotman, 2010). This user-driven innovation changed the microfinance dynamics by sparking non-attendance of group meetings, thereby creating a “breakdown in repayment discipline (Kumar, McKay, and Rotman, 2010)”. MFIs have begun to adopt mobile banking as part of their banking platform due to the extensive gains realized.

Different approaches of mobile banking in microfinanceThe different businesses models for Mobile Money that have emerged over the years can be divided into four categorize: the bank centric model, the MNO centric model, the collaborative model and the independent service provider (ISP) model with two major players: the banks and the MNOs. (Chaixand Torre, 2013). The two most used models are the bank centric model, the MNO centric model.

Bank-led. In this model, it is the bank or financial institution that takes the initiative to provide its clients with a mobile banking service. In this case, the financial institution relies on the infrastructure of the MNO to transfer the data of the transactions, but uses its own branches or partners for the distribution network.

MNO-led. This is the most prominent business model found today.In this setup MNO takes the leading role in the business ecosystem. In the MNO centric business model, the MNO acts as de facto “bank” with limited or no involvement of the financial institutions (Merritt , 2010). The MNO manages all relationships within the business ecosystem, and is responsible for all regulatory compliances (Peake et al, 2012) and the entire value chain. However, often the regulations demand that the MNO store all deposits in trust accounts at a financial institution (Tobbin, 2011).

4. Mobile Banking Regulatory Issues

A key ingredient at the country level is the role of m-banking enabling legislative and regulatory environment. Changes in the legal and regulatory framework can either provide the right conditions for innovative m-banking players to thrive, or hinder its growth by compounding the risk already inherent in the acceptance of a novel product. The challenges of regulation are compounded by the diverse nature of operators in the market – m-banking models vary in their implementation from being entirely bank driven, to being purely driven by a mobile network operator, and more commonly a mixture of the two. Both telecommunication and banking regulators, as well as competition authorities, have a stake in the industry. Nevertheless, many countries have already adopted reforms supporting m-banking environment according to the CGAP (2010) Financial Access database1.

Telecommunications regulatorsTraditionally, the key roles for the telecommunications regulator in an economy’s financial system were indirect: to ensure the reliability and security of the communications infrastructure that connected financial institutions to their customers as well as to each other – the same role played by the telecommunications regulator in most sectors outside of the ICT sector itself.

Financial RegulatorsFinancial regulators also face many questions and concerns regarding their role in the regulation and oversight of m-banking services. Often, financial regulators are empowered to specify the scope of banking services carried out by a financial institution and to issue appropriate banking licenses. A key consideration is that, in general, only banks are authorized to take deposits, and thus the protection of deposits is a key component of banking regulation. (Rolf H. Weber) .On the other hand, credit can often be offered by nonbankinstitutions (NGOs, social development funds, etc.). Taking deposits brings with it a series of prudential regulations to ensure that funds are managed safely on behalf of the customer. Lyman et al. (2008) suggest that non-bank institutions should be allowed to offer stored value accounts under an e-money license, whereas Alexandre et al. (2011) emphasize that regardless of the structure of the model, funds should always be held in a prudentially regulated bank.

1 Such reforms include enabling branchless banking (43 countries), revising Know-your-customer requirements (55), facilitating access to rural areas (46), introducing basic bank accounts (20), enabling microfinance (53) and bolstering consumer protection (65). 64 countries have drawn up strategy documents to improve financial inclusion. See next section for a discussion on how some of these reforms support m-banking.

AML/CFT: In certain jurisdictions traditional face-to-face KYC in AML laws may still apply. These regulations require consumer information to be collected in processes that no longer apply in the modern Payments era. Although the objectives underlying these regulations remain current, the way they are applied to the e-Payments sector can be improved for today’s market. National banking regulations force service providers to obey anti-money laundering (AML), know your customer (KYC) and combating the financing of terrorism (CFT) rules. Alexandre et al. (2011) discuss the issue of KYC and opening accounts, noting that tiered KYC requirements are necessary to fully leverage expansive cash merchant networks. This would allow cash merchants to open limited service accounts and bring more underserved customers into the system. In the case of m-banking and m-payments, financial sector regulators need to determine the appropriate balance between stringent KYC requirements – which may limit access to banking services – and more relaxed requirements that will make it easy for more people to sign up, but that may be less effective for combating money laundering and terrorism. For example, in South Africa the government established a tiered KYC system, under which the existing AML/CFT law was amended to allow the poor and unbanked greater access to banking services by allowing less-demanding registration requirements for certain types of accounts. Certain jurisdictions only permit retail agents to undertake KYC procedures on low-level transactions. These jurisdictions may also impose subcontracting constraints. For instance, agents in India, Brazil, and Colombia, may subcontract KYC procedures if prior consent is obtained from the financial institution (Tarazi & Brelof, 2011).In contrast, Kenya does not permit an agent to delegate customer verification procedures.

E-money issuance: The E-money principle registers whether non-bank institutions can issue electronic money (e-money). For m-banking that is led by mobile network operators, it is especially important that e-money legislation allow them to accept, disperse and move funds under more relaxed regulation than banks. E-money legislation supports openness in m-banking regulatory environment. Definitions of electronic money vary by jurisdiction, but a common definition is ―monetary value stored on an electronic device which is issued on receipt of funds and accepted as a means of payment by parties other than the issuer. Most banks store money in this way (on their computers) and they are regulated in every country simply as bank institutions.Non-banking companies are permitted to issue e-money in an increasing number of developed and developing nations, including the countries of the West African Union, Kenya, Rwanda, the Philippines, Malaysia, Indonesia, Fiji, and Cambodia (Mobile Financial Services Development Report. 2011).

Competition AuthoritiesCompetition authorities, depending on their enabling legislation, are responsible for the enforcement of competition law, including addressing anti-competitive behavior, reviewing and approving or denying merger requests and certain business partnerships, as well as promoting competition. In addition, some competition authorities are responsible for consumer protection regulations. M-banking brings about a market situation in which divergent actors – banks and mobile operators, for example, or even alliances between banks and mobile operators – are offering substantially similar services.

Opportunities for coordination/cooperation among regulatorsPerhaps the most important potential change tothe regulatory regime with respect to m-banking is thenecessity for closer cooperation and coordinationamong the relevant regulators. It is likely that thegreatest coordination will take place between thetelecommunications and

financial services authorities.But other agencies are likely to be integrally involved, such as competition regulator, as well as agenciesresponsible forconsumer protection issues.

Other Key Regulatory Issues

In addition to the need to promote coordination and cooperation among the relevant regulators, another key challenge resulting from the on-going convergence of ICTs and financial services are out-dated legal and regulatory policies.In many economies, the legal and regulatory environments in the banking, competition and – to a somewhat lesser extent – telecommunications sectors were developed or most recently revised well before the convergence of ICTs and financial services. For example, in Peru, banking laws and regulations previously only allowed banking to be conducted by entities with physical locations, but in 2008 was revised to enable branchless banking by allowing licensed financial institutions to make use of agents. Policymakers, legislators and regulators need to review and revise frameworks to account for mobile financial services. (Hernandez, Bernstein, and Zirkle, 2011).

Agent: A key enabler in the eco-system is the agent network utilized to support branchless banking and mobile money. As such, regulators need to address with clarity the guidelines around formation of such agent networks and specific aspects such as types of allowed agents, required permissions, exclusivity, opening of accounts and liability.The ‘agent’ is a central theme in the mobile banking discourse. The agent can be characterized as an intermediary or facilitator in delivering financial services to enhance financial inclusion.2The agent is perfectly situated to deliver services in remote areas and to the unbanked segment of the population due to their proximity within the community (Clara Veniard, 2010), and existing relationships. The agent relationship can be manifested through various business models, such as between the MFI and the bank, or the MNO and the MFI, or the MFI on behalf of a bank. These business configurations bear a myriad of regulatory variables in regulating banking agents. Many countries permit a wide range of individuals and legal entities to be agents for banks. There appears to be no singular formula for identifying suitable entities to serve as agents. In India, post offices, MNOs, shop owners, and retired teachers are allowed to be agents (Tarazi & Brelof, 2011). However, for-profit MFIs, which are registered as nonbank finance companies, are not permitted to be agents (Tarazi & Brelof, 2011). Conversely, in Kenya, only for-profit institutions are permitted to be agents. The underlying policy of disallowing non-profit entities to perform banking agent duties is based on ensuring that non-profit institutions only engage in social operations (Tarazi & Brelof, 2011). Therefore, these examples of agency models, suggest that an NGO-MFI in Kenya cannot be an agent of a financial institution, but may hold that role in India. The functions of a banking agent in certain jurisdictions are subject to regulatory supervision. Vital components in deploying mobile banking services include cash handling, cash management, loan extensions, loan repayment collection and remittance transfers (Tarazi & Brelof, 2011). Each of these services may have different regulatory implications.

Customer protection: In an environment in which m-banking becomes a crucial means of storing value or transmitting payments, who is responsible when there is an error

2 The term “agent” is used to “refer to any third party acting on behalf of a bank (or other principal), whether pursuant to an agency agreement, or other similar arrangement.” Kate Lauer et al., Bank Agents: Risk Management, Mitigation, and Supervision, CGAP, at 3 (Dec. 2012), available at http://www.cgap.org/sites/default/files/Focus-Note-Bank-Agents-Risk-Management-Mitigation-and-Supervision-Dec-2011.pdf.

related to a transaction? To whom should customers address their complaints? What redress mechanisms are in place? What safeguards exist to protect consumers’ personal and financial data? These issues are relevant to all m-banking models, although the responsibility for addressing consumer protection would more likely fall within existing financial sector regulation for a bank based model. By comparison, for a non-bank based model, addressing customer protection may require telecommunications regulators to look to financial sector regulators, as well as possibly consumer protection agencies for guidance, as well as to re-evaluate the tools at their disposal.

Fraud prevention is an important issue for regulators and policymakers. There are four possible types of fraud (Hernandez, Bernstein, and Zirkle, 2011): Money laundering; Agents taking advantage of consumers’ lack of education in order to obtain their PINs and make transactions or change their fees; Agents and consumers colluding together to defraud the system; Customers target agents to defraud the system (e.g. by obtaining access to an agent’s account and sending SMS messages to initiate cash-out transactions).

Interoperability: As m-banking services continue to expand, the issue of interoperability – or the ability to transfer e-money from one m-banking service to another – is likely to become increasingly important. The interoperability principle ascertains if there are provisions that allow customers to easily switch between m-banking providers, which increase acceptance among costumers and competition among providers. Interoperability has also two sub-components. The first looks at interoperability of payment platform by checking whether regulatory guidance is provided for the m-payment platform established by a mobile provider to be open to other providers within agreed time. It also considers if there exist provisions for new entrants to the market to be able to use an existing payment platform. The second sub-component focuses on interoperability of customers. This takes into consideration whether there is mobile number portability regulation in the country. Mobile numbers should be portable so that customers can easily switch between mobile operators and payment providers without losing their existing numbers. Interoperability protects the customer and could be a factor in driving customer acquisition and usage as well as promoting financial inclusion.

Security: Security concerns are paramount for mobile network operators in order to ensure data integrity, connection reliability and customer privacy. Despite consumer apprehension with respect to any form of electronic banking, mobile banking appears to be “inherently safer” than internet or online banking (Frederick M. Joyce, 2010).This is partly due to the physical features built into a mobile handset, such as the phone number and the manufacturer’s serial number (Frederick M. Joyce, 2010). If the handset is lost or stolen, the telecommunications carrier can geographically track the mobile phone, and cancel the service (Frederick M. Joyce, 2010). However, the leading threat to mobile banking remains data theft through fraud or malware.

Regulatory Changes To enable And Encourage Mobile-banking

In addition to reconsidering how to execute existing responsibilities and duties, policymakers, legislators and the regulators themselves could implement more significant changes designed to create an enablingenvironment for m-banking services. The World Economic Forum’s Mobile Financial Services Development Report, identifies several regulatory changes that

could bring more certainty and help promote m-banking, including regulations governing the use of agents to facilitate financial services, the ability of mobile operators to deploy mobile financial systems as a principal operator, the characterization of value stored in a mobile account as a “deposit” (and therefore eligible to earn interest and to be protected by deposit insurance, for example), and appropriate AML/CFT regulation for the mobile context.(Bilodeau, Hoffman and Nikkelen, 2011).The specific topics of focus denoted below identify some regulatory changes that could encourage m-banking.

Flexible telecommunications licensing Form-banking ServicesA country’s current telecommunications regulatory rule may place limits on the ability of mobile operators to offer financial services, such as m-banking or m-payment services. In some countries, the telecommunications regulator may require additionallicenses. For example, value-added service licenses may be required (e.g., China, Kenya and Saudi Arabia) and the specific service to be provided must be included in the license (e.g., Philippines) (GSMA 2007).

Implement Fund SafeguardingWhile licensed banks are generally subject toreserve requirements to satisfy potential depositorclaims, without legislative changes, funds held by nonbankinstitutions are not necessarily subject to anysimilarobligations. Without such protections, thesecurity of customer funds held by a non-bank entitycould be seen as significantly riskier than funds held bya prudentially regulated bank. Regulations ineconomies including Afghanistan, Cambodia, India, Indonesia, Malaysia, the Philippines and the economies of the West African Economic and Monetary Union have been implemented requiring nonbank issuers of e-money to maintain liquid assets at a prudentially regulated bank or sometimes in “safe” assets such as government securities, in an amount equal to the total value of customer funds collected (Michael Tarazi and Paul Breloff, 2010).

Allow For Interest And SavingsAn advantage enjoyed by banks over non-bank providers of m-banking services is the ability to lend the customer deposits they hold, and in return to pay interest on those deposits. So far, e-banking and related regulations have prohibited the payment of interest (profits in case of Islamic banking) to customers and, through measures such as the fund safeguarding regulations described above, prevented nonbank actors from investing customer deposits. The unavailability of interest-bearing accounts removes an incentive for take-up of m-banking services, as well as an incentive for using m-banking services as a vehicle for savings. Two CGAP experts have argued for allowing nonbank e-money to earn interest, given that the regulations prohibiting lending have negated the risk that customer funds would be unavailable for withdrawal (Ehrbeck and Tarazi, 2011). By allowing m-banking providers to offer interest, regulators would create additional incentives for the unbanked to join the banking system. In Sudan regulated MFIs have two types of saving services compulsory (taken as a kind of guarantee) and voluntary savings.

Avoid Additional Taxation And Implement Tax IncentivesPolicies governing the taxation of mobile handsetsand services can affect the adoption of mobile serviceand, by extension, m-banking services. Taxes mayinclude value-added taxes (VAT)/goods and services taxes (GST)/sales taxes that apply broadly across the economy in addition to specific taxes on telecommunications goods and services. Though taxes on handsets, for example, may be significantly offset byoperator subsidies. A 2006-2007 study

of taxation in101 countries found that taxes accounted for anaverage of 17.4% of the total cost of mobileownership (Deloitte and GSM, 2007) In the same vein the author (in his capacity as a manager of banking technology department, at CBOS in 2005) supported by CBOS management requested the wave of customs/vat from ICT goods and service required for adoption of banking technology project in Sudan, request was not approved.

5. Conclusion and Recommendations

This paper demonstrated the regulatory and supervision concerning the microfinance in general and mobile banking microfinance issues as the industry is growing very fast around the globe. In this respect, regulations and supervision should be in place to protect both the industry and the services provided as well as the customers’ receiving the services. Following are some recommendations for regulators and policy makers are involving in the microfinance services and the academic and professionals who are doing research in this area.

Continue to improve regulatory framework for domestic branchless banking and low-value cross-border transfers in Mozambique, South Africa and Zambia

Permit in parallel, as in other pioneer countries (Philippines, Kenya) the development of pilots for domestic (when not existing) and cross-border transactions

As a first step, create regulatory space for domestic branchless banking and low-value cross-border transfers in Angola and Malawi.

In the same way, permit pilots for domestic (as a first stage) transactions.

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