Achieving Financial Inclusion: M-Pesa vs. UPI

This blog post was was written in response to an assignment for the course DPI-662 Digital Government: Technology, Policy, and Public Service Innovation at Harvard Kennedy School. It responds to a hypothetical scenario in the fictional country Niali.

Letter from D. Dagobert, Representative of the Banking Sector in Niali

We welcome the World Bank’s interest in promoting digital payments in Niali. We are writing to request support for a mobile money system modeled after India’s Unified Payment Interface (UPI). We also strongly advise that Mobile Network Operators (MNOs) should be prevented from operating mobile money systems in the style of Kenya’s M-Pesa.

Launching a UPI in Niali would allow Niali’s citizens to make transfers between bank accounts via their phones. It improves the interoperability of the payment system and makes digital payments more convenient for customers. Consequently, it will reduce reliance on cash in the economy, which not only makes the banking sector more productive, but also lowers transaction costs in the economy, reduces currency printing costs for the government, and improves the ability to collect taxes.

An MNO-operated mobile payment system would lack this interoperability. The example of M-Pesa shows that customers would only be able to conveniently transfer money to users of the same telecom. To receive a transfer from another network, the recipient would have to cash in a voucher with an agent.

A UPI-like system would build on the strengths of our banking sector. We have experience and a track record in keeping our customer accounts and assets secure. MNOs on the other hand, have no existing capacity in holding accounts. Many of Niali’s unbanked citizens live in extreme poverty. If these customers lost their assets, or even only temporarily access to their accounts, it would have devasting consequences.

Further, our banks have a long history of developing financial services for Niali’s citizens. Including the poor in the formal financial industry will require ingenuity — the microcredit industry demonstrates that the banking sector can find appropriate solutions. MNOs have no experience with customer needs when it comes to financial products.

The lack of regulation of MNO-operated mobile money systems also poses problems. The example of M-Pesa shows that it can lead to predatory lending and debt crises. Money laundering and the financing of terrorist groups like Boko Haram are other concerns. A UPI could build on a long-standing consumer protection regulation in the banking industry, as well as a robust and collaborative relationship between the banking sector and government should the need for more regulation arise.

Banks engage in a wider range of financial activities, including large-scale loans and investment banking. These more profitable lines of business allow banks to offer less lucrative financial services to the poor without having to capture the whole market. MNO-operated services are limited to small-scale loans. The experience from Kenya shows that an MNO-operated system would therefore only be profitable on a very large scale and would likely lead to a monopolist market structure. A monopoly creates many regulatory problems, and having a large share of a country’s transactions running through one private company poses additional systemic risks to the economy.

A UPI-like system also has the advantage that data on customers’ credit history remains with the bank rather than telecoms. Since only banks offer large-scale loans, this will increase small and medium enterprises’ access to loans once they reached the loan limit with MNOs.

Adopting UPI in Niali will improve convenience, confidence, and convergence of the financial payments system, which in turn will also increase coverage. It is the right choice to further advance financial inclusion in Niali.

Letter from N. Hughes, a lobbyist from a telecommunication agency in Niali

We are writing to urge the World Bank to support the introduction of a mobile payment system similar to Kenya’s M-Pesa. We also want to share our concerns regarding the implementation of a system following India’s United Payments Interface (UPI) model.

An M-Pesa model allows customers to transfer money using a virtual account on their mobile phone. A UPI model only enables transfer between existing bank accounts via phones. Therefore, a UPI model excludes more than half of Niali’s citizens currently not owning a bank account.

Most of Niali’s unbanked population lives off modest to very low incomes. Including these citizens in the financial system will require innovation and the development of new business models in the area of credit, lending, savings. The banking sector in Niali is highly regulated, stifling innovation. The telecommunications industry, if allowed to offer financial products, enjoys the necessary flexibility to come up with solutions that work. M-Pesa history demonstrates the need for experimentation: It was initially created to offer microloans, but during piloting, it was noted that customers preferred to use the system to send funds to relatives.

In finding effective solutions, telecoms could build on their existing relationships with customers. Phone ownership rates exceed bank ownership rates by more than 40 percentage points. And unlike banks, telecoms have a presence in many rural communities through their agent networks.

Existing customer relationships also mean that telecoms will have a trust advantage compared to banks. Albeit on a smaller scale, consumers already trust telecoms with their savings in the form of prepaid phone services. Using prepaid accounts also for transfers is only a small change from the status quo. M-Pesa’s experiences in countries outside of Kenya underpins the importance of trust in the adoption of mobile payment systems.

Telecoms can also leverage customer data on phone use to assess creditworthiness in the absence of detailed credit histories of the unbanked, and thus extend access to small-scale credit. With M-Pesa’s default rate being merely 2%, stories regarding debt crises are likely overblown.

Similarly, concerns regarding money laundering and financing of international terrorism are unwarranted. In the process of receiving the GSMA Mobile Money Certification, M-Pesa was assessed favorably regarding these risks. Like in Kenya, Nialian telecoms collect national ID information when opening phone accounts, making sure that every account can be linked to individuals. The banking sector may to date have a closer relationship with regulators than the telecommunication industry, but banks’ influence on regulation may not always benefit customers.

Progress in advancing financial inclusion in Niali over the last years was modest which underlines the need for a new approach. M-Pesa’s success in Kenya demonstrates that MNO-operated mobile payment systems can be a steppingstone to including customers in the formal financial system. It should be the next step for Niali’s financial system.