Thoughts on Open Banking in Kenya

My take on the recent National Payments Strategy document by the Central Bank of Kenya

Just before Christmas the Central Bank of Kenya (CBK) released a report titled “Kenya National Payments System Vision and Strategy, 2021 – 2025”. The report details CBK’s plan and vision for the payments system in Kenya. It is a very timely document and I am happy that the CBK is taking this step. I had been of the opinion that the Kenyan financial system was getting complacent on the success of M-Pesa so this report calms my concerns.

The document details the historical evolution of Kenya’s payment system and gives a sweeping view of where it expects to be in 5 years-time. You can download the report here. The main aspects detailed in the report are;

1.    How to deepen trust in the National Payments System (NPS);

2.    How to make the NPS more secure for payment participants;

3.    How to make the NPS more useful to all system participants;

4.    How to increase choice for consumers;

5.    How to foster innovation within the NPS;

Within the elements of driving choice and innovation within the NPS, the Central bank talks of open standards and data portability. This then naturally opens the door towards a regulator driven implementation of open banking in Kenya.

Open Banking in principle means that in principle customers own their data, in this case bank and M-Pesa data - and should therefore be able to give any approved third party institution access to their data in a controlled and secure manner.

Open Banking principles have existed for a long time; you have always been able to share your bank statement to any third party of your choice. Open Banking as it is envisioned and practiced is based on Application Program Interface (API)-driven and permissioned enablement of data transfer between your bank and a third party app for either payments initiation or data orchestration.

In Europe and particularly the United Kingdom, Open Banking is driven by two main pieces of regulation. The General Data Protection Regulation (GDPR) as well as the Payment Services Directive (PSD2). These two pieces of regulation cover two key facets of Open Banking – giving a third party “Access” to your data and giving them the ability to “initiate payments”. This is quite intuitive. If someone is accessing your account, they want to have information about your account and they want to be able to execute a payment. In Kenya, the CBK is riding on the National Payment System Act (2014) as well as the Data Protection Act of 2019 although more work is required to update these Acts.

Why does Open Banking Matter?

The current financial system in Kenya and globally is based on siloed data architecture. What this means is that data both within institutions and external data is held in separate databases which don’t communicate with each other. For instance, if you have two bank accounts you have to log into the respective apps to find out how much you have in each account. You then have to manually sum up your total bank balance and financial position. Additionally, if you have want to renew your insurance through bancassurance, the bank has to get in touch with the brokerage to know when your insurance is expiring and how much is the renewal premium. Internal data i.e. held within the same bank group is siloed and external data i.e. between two banks is also siloed. Customer data is central to a bank’s business model as data informs who to lend to, how much to lend and when to lend.

This feature has existed by design because it makes switching of banks difficult and incentivises a bank customer to keep one bank account since it’s much easier to manage one account. I personally would like specific services from one bank but I’m hesitant to terminate my relationship with my existing bank because of the fact that I have existing credit lines with it. The customer relationship is the cornerstone of a bank’s business model. Typically bank relationships particularly for older generations were like marriages, you were together for life through good times and bad times.

Open Banking turns this on its head and forces banks to share customer data to third party institutions. This then enables innovative Fintech companies to orchestrate data in a much more intuitive manner for the benefit of customers. Bill Gates once said that “Banking is necessary but banks aren’t”, in an Open Banking world we could see this come to pass.

Open banking works on two key strands; Access Initiation and Payment Initiation. Access initiation basically covers the accessing of bank data such as balances, statements and other relevant client specific data by a third party. Payments initiation covers the aspect of third party providers initiating a payment through your bank on your behalf. The two need to work in tandem for the greater benefits of open banking to be achieved.

Numerous use cases can arise from an open banking model that would add more value to customers. In the case of Kenya, 67% of Kenyans are under the age of 30 meaning that Gen Z’s and Millenials form the bulk of the population. Open banking will give rise to new banking models for generations which are digitally native.

Playbook

For CBK

For Open Banking to truly work, Kenya needs a robust lower value payments system. Currently, lower value payments are done via M-Pesa or cash. Higher value payments are executed via RTGS, EFT and Cheques. M-Pesa is thus the de-facto lower value electronic payments system. This then exposes CBK to the dilemma faced in 2020 where CBK ended up imposing price controls on a private sector player i.e. Mpesa so as to cushion Kenyans from the negative impacts of Corona. CBK needs to consider the following;

1.    Creating or driving the creation of a lower value payments system – PesaLink was supposed to play this role and still can but so far PesaLink hasn’t lived up to the expectations expected of it. This topic deserves a blogpost on its own;

2.    The lower value payments system should also be based on an identity system such as Huduma Namba – India’s UPI is a perfect example – here is a good breakdown of UPI;

3.    Within such a system as described above, CBK should focus on enforcing standards, access protocols and prerequisites as well as system performance;

4.    CBK needs to develop a whole department with significant resources that will focus on technology leadership, cybersecurity, security standards, IT audits and other elements required to run a robust IT infrastructure;

5.    With ever changing technology and business models, CBK needs to adopt a more proactive approach to regulation by creating policies and guidelines that relate to fintech platforms that may or may not yet exist in Kenya. Additionally, it would be important to regulate by function. For instance if a company lends, it should be regulated like a normal lender. This would avoid disadvantaging incumbent businesses. We have already seen this with interest rate caps where digital lenders have been able to continue lending at much higher rates. 

6.    Drive the open banking agenda aggressively on a principle based approach – the document is a good start because it is based on principles such as trust, security, innovation, choice and usefulness. CBK needs to show strong leadership on this because it is likely that incumbent financial institutions may oppose the radical transformation of their business models;

7.    Within this, standardisation of API pricing should be a priority. Banks could overprice API access costs and thus defeat the whole principle behind open banking;

For Banks

Open Banking may render some business models obsolete. A quick glance at the Google Play ratings of bank apps in Kenya shows that banks don’t do a great job at creating digital experiences compared to their peers in Fintech. The history of digital channel development in Kenya in my view has been one of pushing existing customers to digital channels rather than creating robust customer acquisition mechanisms.

With data portability, companies down the customer experience value chain may add financial service offerings. A car website such as Cheki for instance will be able to pool customer bank data, define an affordability profile and sell a car on instalments based on the customers financial profile. This applies to a multitude of customer use cases.

1.    Banks first need to clean up their data architectures so as to be able to have a better view of their customers – you would be surprised at just how little your bank knows about you from a financial perspective. It is quite strange that at this day and age when you apply for a bank loan, your own bank will ask you for your bank statements. This is already happening from what I understand with data scientists and analysts being frequently recruited;

2.    Create new Standard Operating Procedures (SOP’s) and policy documents regarding open data and data governance. Business models are more likely to be adopted if the compliance guy has a document he can fall back on;

3.    Strategy heads need to think about customer journeys rather than selling financial products. Many people need loans or payment services to do something, be it pay school fees, buy a car, pay rent etc. Banks could start by defining a user journey and building products lower down the value chain. An example is maybe a school enrollment and management software that enables schools to digitise. The bank can then embed financial services by financing parents – converting fees into weekly or monthly instalment loans as well as financing teacher payroll lending. Another example is that payroll software providers can become the biggest check off loan  providers because all they need is additional bank data to calculate affordability. The payments layer can then execute disbursements and collections;

4.    Create Venture Capital capabilities within the organisation – a lot of the real innovation within the Fintech space will happen outside the banking sector. Banks thus need to develop the capabilities to identify and invest in smaller companies whilst building the skill sets required to absorb these smaller companies into the organisation. Within the African context where the Venture Scene is still fledgling, big banks can step in with smaller cheque sizes to incubate companies innovating within the financial sector;

5.    Through a formal body such as Kenya Bankers Association (KBA), banks need to create a body that guides the discussion on standardisation of APIs, pricing, security protocols and other elements that should be of interests to banks. Open Banking Europe is a good example. Additionally, the KBA should also lobby for open data across industries including Telcoms, utilities and many such industries. Open banking could unfairly disadvantage banks therefore it’s only fair that other industries also open up their data to third parties.

For Fintechs

This is where it gets really exciting. The number of possibilities is almost endless. Globally, we are at the foothills of the Open Banking story and some of the business models are just unimaginable. Open Banking to me is a transformative technology whose long-term ramifications are difficult to predict from our current vantage point. Of course within the Kenyan market the following business opportunities jump out of my head;

1.    The most immediate business model revolves around Access Initiation Service Providers (AISP) and Payment Initiation Service Providers (PISP). These are the services that actually abstract APIs from all the banks and provide one simple API to Fintechs to consume – globally examples like Plaid and Tink stand out. I think there will be a lot of growth within this sector. Nonetheless I see the long-term economics of AISPs becoming utility like with the prospect of price regulation. Of course, utility like economics within the software domain will still be very profitable because there is less capex than a typical traditional utility. However, there will be little or no product differentiation whilst competing on price leading to non-compelling industry economics. Monopolisation will be difficult because I don’t think the regulator would allow only one AISP.

2.    Existing marketplaces can add deeper functionality to their existing products. Online property agents such as Pam Golding or BuyrentKenya can add financial capabilities to their service offering. You could apply to acquire a house and immediately get a mortgage offer immediately. The marketplace wouldn’t actually have the mortgage on their balance sheet but could act as a mortgage broker which does checks on both the buyer and the seller with online loan origination and payments done at the bank level;

3.    There will be significant value in business software providers. Companies that enable SME’s to do payroll, tax, accounting and other business services will be able to embed open banking to their existing products. Millenials and Gen-z are digitally native and would be happy to have a service where they can run all aspects of their business from a phone or tablet without any human interaction;

4.    A number of Tier 3 and 4 banks may struggle with their open banking initiatives due to less robust core banking architectures – there will be an opportunity to help these institutions upgrade their systems. Additionally, I think Tier 3 and 4 banks with smaller balance sheets will have a significant opportunity to convert into purely digital native banks. The larger ones have more legacy infrastructures to write off and this may be too expensive for them to execute;

5.    A bank agnostic agency banking service. Currently each of the big banks have their proprietary and exclusive agency banking programs that predominantly run on card and POS technology. If the CBK delivers with a low value payment system such as UPI of India – there will be a significant opportunity to offer agency banking for all banks. Agency banking ultimately is a funds transfer mechanism. A pure agency banking play will need significant numbers to be economically viable but at scale can be very lucrative. The agency platform will have significantly lower cost to serve as it can run on biometrics as well as mobile based transaction initiation as opposed to cards;

6.    MFI’s have a brilliant opportunity to grow their lending businesses. One of the first orders of business will be to create websites or apps that quickly derive a credit limit when fed with specific banking information. In fact, this service would better be provided by a lending marketplace which would create credit profiles of applicants and present these applicants to credit institutions who would then be able to make the most competitive offer to the applicants. The existing Stawi system could be significantly upgraded within such a framework.

7.    Ultimately one of the biggest beneficiaries of Open Banking could be M-Pesa. Already, M-Pesa is the digital wallet to over 30 million Kenyans. With Open Banking capabilities, M-Pesa can be your one stop financial service provider. Pull capabilities can be executed within M-Pesa where you can view your bank balance and pull a specific amount into your M-Pesa without leaving the app. I see a significant opportunity within the SME space particularly if it rides on top of the M-Pesa for Business app.

All that said, the ball is in CBK’s court and they have to shepherd this process to its ultimate conclusion; a future in which open banking is fully implemented in Kenya.

Thanks for reading and drop the comments below;

If you have any queries or would want to discuss specific aspects further – reach out at samora.kariuki@gmail.com