# 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.

The 90s and early 2000s saw significant stress in the banking sector. Non-Performing Loans had shot through the roof across the continent and banks were significantly under-capitalised. It was a situation of Zombie Banking where the indigenous banks that had been formed were barely functional and large foreign owned banks such as Barclays, Standard Chartered and Citi dominated the scene. Local indigenous banks on the other hand neither had the technical capacity nor the balance sheets to really fulfil their mandates. Foreign banks focused on narrow yet lucrative niches of banking Multinationals, Large local corporates and a select group of people for personal banking. The result was barely any innovation in the delivery of financial services and exclusion of wide swathes of the population. Customer service was in the pits.

Subsequently, it was clear that Central Banks needed to create a more stable banking environment. In Nigeria for instance, the Central Bank of Nigeria mandated banks to increase their capital requirements from around US$ 15 million to approximately US$ 190 million. This was expected to be done within a time frame of 18 months.

This period can be thought of as the ‘Great Consolidation’ and the Nigerian banking system went from having 89 banks to 25 banks through a mix of mergers, acquisitions, capital raises and liquidations. Notable mergers and acquisitions during the consolidation period included:

• Access Bank merging with Marina Bank and Capital Bank International.

• United Bank for Africa (UBA) merging with Standard Trust Bank.

• First City Monument Bank (FCMB) acquired Cooperative Development Bank, Midas Bank, and Nigerian American Bank.

• Stanbic Bank merging with IBTC Chartered Bank (now Stanbic IBTC Bank).

Similarly in Kenya, the Central Bank introduced new capital requirements in 2008 that would see bank capital raising from KES 250 Million roughly US$ 2m to KES 1 billion (US$ 8m). Given that the capital increase wasn’t as dramatic as in Nigeria, there was minimal consolidation with more banks opting to raise capital. A proposal in 2015 to increase capital to KES 5 billion was rebuffed but now the Central Bank of Kenya is talking of increasing capital to KES 10 billion or roughly US$ 80m.

In essence an explosion of banking licences in the two decades prior to the 2000s was followed by a period of consolidation. Central banks from an economic perspective rightfully focused on economic stability and that bigger banks were better suited to drive economic growth. A larger bank can finance larger projects and technically can allocate more credit into the economy. In the period since the 2000s there have been hardly any new banking licences issued. 

In retrospect, this focus on stability has been successful. African Banks are well capitalised, can allocate credit into the economy and are well managed. In fact, most of the M&A in the continent is now being driven by large African Banks expanding where foreign banks are retreating. Examples of Access Bank acquiring Standard Chartered’s assets in Africa and Equity and KCB expanding into the DRC.

Unfortunately, barely any new licensing frameworks have been developed that would see new banking challengers emerge. Where Central Banks have attempted to enable competition, the result has been bastardised licences that at the core ensure that new entrants never challenge the revenue pools of incumbents. Payment Service Bank licences as well as Micro-Finance Bank licences have restrictions designed in such a way as to ensure that entities operating on these licences never reach escape velocity. If you could summarise the restrictions, it’s simply, don’t touch FX (GT Bank without FX would have had a horrible couple of years), don’t lend sizable amounts of money and focus only on people who are so poor as to not be economically viable.

This is unlikely to change in the medium to long-term.

Emerging Global Regulatory Approaches

Given the need to balance between innovation and financial stability, Global Central banks seem to have taken three different approaches;

1. Bespoke digital banking licensing framework;

2. Phased authorisation of digital banks;

3. No separate licensing but support towards full licensing;

Bespoke Digital Banking Licensing framework

These are licenses carved out of each Central Bank’s regulatory framework to cater to digital banks. These are usually defined as banks that provide banking services including deposit taking exclusively through digital means. Moreover, they need to prove that they are enabling financial inclusion by targeting previously unbanked or under-banked groups. Examples include;

1. 🇵🇭 - The Bangko Sentral ng Pilipinas (BSP) offers a digital banking licence, allowing digital banks to operate with the same regulatory framework as traditional banks, while focusing on financial inclusion. Examples of banks licensed under this framework include GoTyme Bank and Tonik;

2. 🇰🇷 - The Financial Services Commission (FSC) introduced a Specialized Bank License for digital banks. Leading digital banks in South Korea include Kakao Bank and K Bank, which provide a range of services from deposits to lending and card issuance;

3. 🇭🇰 - Hong Kong’s Monetary Authority (HKMA) launched a Virtual Banking Licence in 2019 to encourage digital-only banking operations. These licences have been granted to banks like WeLab Bank and ZA Bank.

Permitted activities include deposit taking, card issuance, credit provision, payments and forex services. Restricted activities include opening branches, must focus on retail and SMEs initially and often deposit caps in the early years;

Phased Authorisation of Digital Banks

These are licences or frameworks that enable digital banks to start off without a full banking licence as they build up their capacity and business models. These frameworks enable an institution to operate in a restricted manner in the early years. Some examples include;

1. 🇦🇺 - The Australian Prudential Regulation Authority (APRA) introduced the Restricted Authorised Deposit-taking Institution (Restricted ADI) licence, specifically aimed at digital banks. This allows Challenger Banks to operate under lighter capital requirements during their early stages, before transitioning into full ADI status. Digital banks like Volt Bank and 86 400 obtained this licence but both failed;

2. 🇬🇧 - The UK offers a full banking licence through the Prudential Regulation Authority (PRA) and oversight from the Financial Conduct Authority (FCA). The PRA grants digital banks like Starling Bank and Monzo the same rights as traditional banks, allowing them to offer deposits, loans, and payment services.

No Separate Licence of Digital Banks

Whereas in this framework there is no licence carved out for digital banks, regulators have taken a more favourable approach to issuing banking licences to challengers;

1. 🇿🇦 - TymeBank in SA received it’s license in 2017 from the SARB and was the first bank to receive a new licence since 1999;

2. 🇧🇷 - Brazil have a unique approach in that there’s a licence called the Sociedade de Crédito Direto (SCD) licence, which allows digital banks to lend and provide financial services digitally, but without traditional banking activities like deposits. Nubank started off with this licence;

The challenge with this framework nonetheless is that some restrictions that apply to traditional banks in some jurisdictions such as an objection to digital onboarding hamper the growth of digital banks.

BaaS in the African Context - Why it matters, how to make it work and who the players are;

So far, we have understood the following;

1. There is a need to innovate in the provision of financial services driven by an inclusion gap as well as the mindset that we should always encourage innovation if we want to avoid economic stasis;

2. Banking regulation in Africa is governed mostly by the need to ensure financial stability as well as promote large banks that can drive economic growth. This comes at the expense of enabling innovation and competition in the banking sector;

3. Globally, different central banks faced with a similar inclusion gap have adopted novel ways of enabling digital banks to set up and get going.

My long-term view for Africa is the following;

1. Central Banks will continue focusing on scale and consolidation thereby ensuring that African banking markets look like the UK and Australia with big 5 dynamics over the long-term. The recent capital raises in Nigeria and Uganda prove this out.

2. The dance between Central Banks and Banks will shape the regulation of “new banks”. If Nigeria is anything to go by, we will continue seeing what I call “bastard” licences that are a straitjacket to the entities that have them.

Bigger banks won’t focus on innovation in the same way a smaller bank would. How this filters down into “innovation” is that a project needs to meet a much higher “hurdle-rate” for it to make sense. If I’m a product manager at a large Nigerian bank for instance, driving a proposal for a product that at most can generate US$ 1m per year in two years will not move the needle for a bank that has US$ 400 million or even US$ 120 million in capital. Zero billion dollar markets are therefore not explored given that it makes more sense to do large ticket loans or lend to the government. This has played out globally, the increased capitalisation for Tier 1 global banks led to the growth of not only Fintechs, but Private Credit.

Simply, the demand for modern financial services is there and is growing. However, the supply of these modern services is constrained by the current regulatory landscape in Africa where the focus is on large banks. Banking as a Service therefore becomes a useful way for a large bank to leverage its technology and infrastructure so as to enable smaller Fintechs to solve these zero billion dollar market problems. This is a very logical conclusion. 

Some considerations for BaaS;

What Services and Infrastructure is Required;

Larger banks will be able to invest more in stable infrastructure. We’ve seen this with Nigeria as banks like GT Bank upgrade their core banking systems to more modern versions of Flexcube, Finacle and others that now have API capabilities. In East Africa, I&M, Stanbic and NCBA have all upgraded their core banking systems and have spent quite a good sum doing this. This new infrastructure can enable BaaS. The key services that need to be enabled via API are;

1. Basic accounts and wallets;

2. Payments - EFTs, Mobile Money, Cards and other payment types;

3. Card Issuance;

4. Compliance and Screening;

5. Financial Crime Reporting;

6. KYC & AML Capabilities;

7. Potentially, credit risk support i.e. enabling Fintechs have access to rich credit data at a fee for their own credit modelling

At the minimum, these are the key functionalities that need to be exposed via APIs. I wrote about BaaS a few years back and explained how there are different approaches to BaaS. One can be a pure licence play like Evolve Bank and Trust. Another approach is a hybrid approach like Cross River where you offer both the technological infrastructure (APIs) and the licence. Lastly, one can focus on just the technical layer like Marqeta.

The decision on whether to be a hybrid provider like Cross River will depend on your technical chops. My recommendation is to work with a technology provider like Skaleet, Anchor, Mono or Ukheshe to provide and manage the API layer.

Keys to Success

For banks to succeed in BaaS, the following are core requirements;

1. Hyper Focus on Compliance - The need for BaaS and the business case to me is clear. The downfall so far has been in compliance. Banks that focus on BaaS will have to perfect their compliance efforts and this will include;

   1. Having visibility into the ultimate beneficial owners of all entities that your Fintech partners onboard. This should be done at onboarding and in regular intervals through some kind of screening software. The Synapse fiasco is simply down to the lack of this visibility;

   2. Building relationships across the regulatory complex to be able to quickly understand Fintech business models and the nature of compliance risk that is involved in such businesses. This enables smoother onboarding;

2. World Class Leadership - Banks taking on BaaS will need world class leaders for these BaaS divisions. Currently people think of BaaS as serving small Fintechs but I see large Microfinance organisations, Credit Unions (Saccos) and other larger organisations also needing BaaS services. You need strong leadership that can do the following;

   1. Educate regulators on BaaS and work together with them to build common regulatory or oversight frameworks;

   2. Have good relationships with regulators to the point of being on a first name basis with the Central Bank governor to enable faster “no objections” or approvals for all clients onboarded;

   3. Be extremely firm with Fintechs both large and small - this person needs to be able to get on the call with the CEO of a large fintech like Flutterwave and Paystack and give them a dressing down if needed;

3. World class technical capabilities - Whether you run the BaaS yourself or work with a technical partner like Skaleet, Ukheshe or Anchor, you need strong technical capabilities focused on BaaS.

4. Networked BaaS for standalone API players - If you’re an API only player like Anchor or Mono, some consideration needs to go into how you structure your banking relationships with a view of having a networked system. This means that if a Fintech sets up a product with you and starts collecting funds into their wallets, these deposits need to be spread out across a number of banks to reduce the risk of failure with clear reporting and visibility across all these banking relationships;

5. For stand-alone players - Another key differentiator will be the depth of trust you have within the banking system. I see traditional Core Banking players having an advantage. That’s why Ukheshe was able to work with DTB on their Astra proposition. These traditional players have trust and relationships within the industry and are seen as more mature. There’s an opening for the likes of Craft Silicon and others to play in this space.

Economic Value for Embracing BaaS

“In a world that's changing so quickly, the biggest risk you can take is not taking any risk” - Peter Thiel

There are a number of benefits that make BaaS a viable option for large banks. They are;

1. New Revenue Streams - Enabling payments, account opening and card services can generate new revenues such as.
   
   

   1. Interest from deposits;

   2. Issuance fees for card payments;

   3. API fees;

   4. Transaction fees;

I always argue that CBA, now part of NCBA grew on the back of Banking as a Service to M-Pesa;

2. Enabling zero billion dollar markets through BaaS enables you to have a front seat into what works and what doesn’t work. You can then take advantage of this in a number of ways;

   1. Acquiring the most promising start-ups and adding them into your ecosystem;

   2. Leveraging these learnings to inform your corporate venture strategy if one exists;

   3. Launching your own stand-alone propositions;

3. Developing internal competencies around API management, embedded payments and Fintech that will bleed into your other innovation efforts.
   
   

Players - Current and Future;

There are a number of players to watch out for. The best way to look at this is to look at the banks and non-banks i.e. the banks that will support BaaS and the players that will provide infrastructure.

Banks

In East Africa, Diamond Trust Bank has made quite a bold effort at providing BaaS with their Astra proposition. It’s a very bold and impressive effort. Boya has already launched a corporate expense platform on top of DTB’s Cards as a Service platform and I know a few others who are working on fintech apps powered by Astra. Astra’s core proposition includes; Compliance, KYC & Onboarding, Accounts, Wallets, Payments and Cards. Equity bank has their Jenga API run on their Finserve platform. Other players like I&M and NCBA have been speaking about Fintech ecosystems but haven’t as yet launched their own dedicated BaaS platforms. In West Africa, Providus Bank and Wema have been the poster boys of Fintech enablement in Nigeria. I expect Sterling Bank to join the ranks given that they’ve recently upgraded to their own in-built core banking system. This should enable them to provide BaaS at both the licence and tech layer. Of course, one can’t talk about BaaS in Africa without talking about Ecobank which has for many years played a pivotal role in Fintech enablement. Companies such as Fingo run on Ecobank’s infrastructure and they have been the go-to guys when Fintechs want to launch payment propositions in the continent;

Infrastructure Providers

I look at the Infrastructure providers and bucket them in three buckets;

1. Pure play BaaS providers;

2. Core Banking players;

3. Sleeping giants;

Pure Play Baas Providers - These are start-ups that have set up specifically to be the API layer between banks and Fintechs. Fintechs therefore just need to connect with them and immediately start providing their services. They provide the APIs as well as the relationships with the licence holders. Some players include Anchor and Mono. All were founded in Nigeria where there has been a more active Fintech ecosystem. Mono has clients such as Carbon and Flutterwave. Anchor has clients such as Bujeti and Outpost Health offering a mix of card and wallet services. The challenge here is staying in the game long enough to earn trust with the big players.

Core Banking Players - These are core banking platform providers. They currently operate within the BaaS ecosystem by offering the technological infrastructure to banks so as to enable them to offer BaaS directly. In as much as they’re currently only facing banks, I see an opportunity for such players to market themselves to fintechs directly. A company like Craft Silicon for instance is already powering Little Cab with BaaS and they can easily extend this service to other Fintechs as a pure stand-alone play. They have all the relationships with banks and they have the data that allows them to create a networked BaaS solution like Mercury. This is where you distribute deposits and functionalities across banks so as to reduce the risk of a single point of failure. M2P in India is a player to watch given their recent fund-raise led by Helios. The mix of technology and relationships could be a winning combo.

Sleeping Giants- These are companies that don’t yet have a clear focus on BaaS but have all the infrastructure necessary to offer it at scale. Some players here are Flutterwave, Paystack, Paymob, Rafiki and MoMo players like M-Pesa. Simply, they have the relationships, sophistication, trust and technology to execute. They can easily scale this up across the continent.

Wrapping it Up

It’s clear that there is an unmet demand for a new type of financial service provider given the changing face of production and consumption. Banks cannot be the only ones to solve this problem. The lack of new licensing frameworks for challenger banks therefore creates a supply problem. To meet this supply problem, BaaS is a natural solution that would enable Fintechs to innovate whilst riding on bigger banks licenses. To win, one would require technical sophistication, compliance rigour and deep trust within the ecosystem.

As always thanks for reading and drop the comments below and let’s drive this conversation.

If you want a more detailed conversation on the above, kindly get in touch on samora@frontierfintech.io