# 56 The Big BaaS Opportunity in Africa

Why the African banking market lends itself naturally to BaaS and some considerations on execution and commercialisation

Artwork by Mary Mogoi - Website

Hi all - This is the 56th edition of Frontier Fintech. A big thanks to my regular readers and subscribers. To those who are yet to subscribe, hit the subscribe button below and share with your colleagues and friends. Support Frontier Fintech by becoming a paid subscriber🚀

Like previous editions, I’ve added a Notebook LM generated audio summary. If you’re in a hurry, the audio summary does a fantastic job at summarising the key points in a succinct 14 min audio.

Introduction

When I decided to get back to Frontier Fintech on a full-time basis, I knew that I had to do it in a proper way. I’d have to create an entity and run a proper business if I were to scale this to the heights that I envision this newsletter scaling into. As a newsletter, less than 20% of my readers are from Kenya and in fact, I have readers from over 100 countries with the US accounting for around 15% of my readership. This showed that I had to create a global business that can trade easily with the rest of the world. A Delaware incorporation therefore made tons of sense. I created a plan and registered a business through Stripe Atlas. The Stripe dashboard took me through all the steps of creating a business from legal incorporation, setting up my cap-table, registering with the IRS and eventually opening a bank account. The bank account was powered by Mercury and within a couple of days after getting my IRS details, I had a bank account. I was all set up to start receiving payments through Stripe into my Mercury bank account. The experience was topped off by me receiving my Mercury debit card via DHL. This entire experience was powered by two key themes that should matter to bank executives in Africa.

Zero-Billion Dollar Markets - Frontier Fintech like many others is building an entirely internet based media business. My intent is invisible to most bankers. I can’t even imagine what a conversation with my bankers in Kenya would have been like. I’d have approached them and said that I’d like to incorporate a business, set up internet payments infrastructure and start receiving money from potentially over 100 countries worldwide. The Relationship Manager (RM) would have called the compliance person and we’d have stared at each other in a meeting room at the branch for over an hour. Frontier Fintech is an internet business enabled by the convergence of a multitude of technologies. I’ve written about these emerging SME’s numerous times. Jensen Huang refers to this as “zero-billion dollar markets”. These are industries that you can see as an entrepreneur but nobody else can. Nvidia saw the zero billion dollar market in making graphics cards for the gaming industry. Equity Bank over 20 years ago saw the opportunity in SME banking and Safaricom saw the mobile money opportunity. They were all zero billion dollar markets. Financial services for Internet businesses and gig work are zero billion dollar markets.

The other theme is Banking as a Service. Banking as a Service (BaaS) allows non-bank companies to offer financial services by using the infrastructure of a licensed bank. Through APIs, businesses can integrate features like payments, loans, or account management into their platforms. This makes it easier for fintechs or other companies to offer banking services without becoming a bank themselves. Mercury uses BaaS and rides on a number of relationships. The Generalist does a great job at explaining how Mercury utilises Banking as a Service. When I’m paid, money goes to Choice Financial Group which is the BaaS provider for Mercury. In as much as the Synapse fiasco has caused a backlash against BaaS, I argue that as Mark Twain said “Reports of my death are greatly exaggerated”.

This week’s article will lay out why Banking as a Service is a massive opportunity in Africa and why banks and Fintechs need to give it the seriousness it deserves. I hope to bring out the arguments for Pan-African BaaS and why I think this is a product that requires long-term consideration. The argument is brought about by a number of considerations;

1. The opportunity that is driving demand for new financial services - the Zero-Billion Dollar Markets;

2. Why the banking sector cannot take advantage of this opportunity;

3. How other regions have enabled digital financial solutions through regulation and why this is unlikely to be replicated in Africa;

4. The resultant need for Pan-African BaaS;

5. Some considerations on how to make BaaS work;

6. Some of the players to watch in this space;

The Drivers for BaaS

Innovation in Financial Services in Africa needs to be seen from two perspectives. The first is the idea of the financial services gap i.e. the market’s failure in advancing credit and other financial services to some customer segments. This is usually represented as a financial inclusion gap. The second is the concept of the emergent properties of financial innovation i.e. new products and solutions that emerge when innovation is allowed to flourish.

The experience of Mobile Money and Fintech in Africa shows that non-banks have a huge role to play in financial innovation.The innovation brought about by such players simply can’t be done by incumbents due to a number of factors;

1. There is a latent barrier to how much incumbent institutions can drive financial inclusion. Financial inclusion in Africa is 49% compared to European inclusion rates of 90%. A large driver of this inclusion gap is the distribution model for banks which is still largely brick and mortar. Given the size of the continent, the dispersion in population and the GDP per capita, brick and mortar banking simply cannot scale. Mobile Money was the first wave of inclusion through wallets, a second wave may be necessary to drive overall financial empowerment;

2. There is an SME finance gap which is estimated at being over US$ 330bn in Sub-Saharan Africa alone. This requires new ways of distributing financial services that at the core has discovery and credit analysis as key planks;

3. A new demographic breed of gig workers, remote workers and employment trends that are moving away from permanent and pensionable staff is driving a new type of exclusion. Banking products have traditionally relied on standard customer archetypes driven by standardised credit risk and compliance models. The growth of gig, remote and short-term contract workers is driving a need for new types of financial services. This is driven by both how customers receive their payments and how they can access loans. Additionally, like my experience with Frontier Fintech, there’s a new breed of businesses that is being created that does not fit any existing customer archetype. There’s a gap here.

4. A younger, more digital savvy population requires digitally savvy products. The increased discrepancy between consumers’ heightened expectations of their digital services and the perceived experience of their banking apps has led to a situation where African banks have lower than usual NPS scores with only a few outliers;

In short, there are underlying factors that drive the need for continued innovation in financial services both at the infrastructure and customer layer. Moreover, it is reasonable to assume that banks won’t solve these problems all on their own. This is due to both organisational priorities and a structural inability to do everything. Banks usually approve projects based on “business cases”. These business cases need to show that if the bank invests x, there should be a 5x return within a very short period. Zero billion dollar markets don’t work like that. This hyper-focus on business cases which has its merits, leads to situations where promising projects aren’t approved and worse still, large projects that look good on paper get approved leading to white elephant Fintech projects. Vooma by KCB is a perfect example.

Additionally, innovation for innovation’s sake is important for two reasons;

1. Mario Draghi recently released a report stating how the divergence in European and American economic growth is down to stagnant productivity growth in Europe. He goes further and states explicitly that technology has been the biggest driver for this divergence. Simply, the lack of tech innovation has been a drag on Europe’s economy; 

2. Innovation also has emergent properties. To give an example, Digitax is a company in Kenya that enables tax compliance through an integration into Kenya Revenue Authority. Their stated business focuses on enabling companies to be E-Tims compliant. This is done through an integration that enables the revenue authority to have direct visibility into each invoice that a company generates. Digitax enables this real time communication between a company’s invoicing system and the revenue authority. Nonetheless through this, an emergent property is that Digitax can enable invoice verification for the Supply Chain Finance industry solving a problem that has plagued the industry.

In summary, there are legitimate drivers for financial innovation in Africa. 

Why the Banking Sector Will not lead the Innovation - Regulation

To understand why banks can’t be solely relied upon to innovate, one has to look at the banking regulatory landscape in Africa and take a long view on how the banking sector has evolved over time. The period between the 1970s and the 2000s can be considered the Wild West of African Banking. There was a Cambrian explosion of banks that was driven by a liberalisation drive brought about by the IMF as well as a drive for increased indigenisation of the banking sector. In Nigeria alone, over 100 banks were licensed between 1970 and 2000s. In Africa, Notable names such as GT Bank in 1990, Equity Bank in 1984, I&M Bank in 1974, CRDB Bank in Tanzania in 1996 and Zenith Bank in 1990 were all formed. The growth of the banking sector in this period led to a situation in which the number of banks exceeded the capacity of regulators.