Lateral Thinking: Open Banking and Embedded Finance in Africa — Part 3

Introduction

Last year, we put out a series of articles (part 1 & part 2) that looked at how open banking had developed across the globe. Whilst the evolution of open banking ecosystems differ greatly in different markets; generally, the adoption of open banking was driven by a combination of three primary factors: regulation, technology, and changing consumer demands. Regardless of the drivers, we concluded that incumbent banks across the world were faced with a clear choice: either adapt their core value proposition or be disintermediated in a world where consumers are able to seamlessly share their data across multiple financial service providers.

In this edition, we hear from some of our portfolio companies that are at the forefront of building the open banking ecosystem in Africa. Enablers such as Appzone, B54, Mono, and Pngme are on a mission to allow data and capital to flow seamlessly between incumbent/microfinance banks and a wide range of fintechs including digital/neo banks, lenders’ payment gateways, and embedded finance players. This will in turn facilitate a wide range of data-driven products and services from credit, interbank services, KYC, cross-border services, and float management.

We will also get input from Open Banking Nigeria, an NGO tasked to advance open APIs within the Nigerian financial ecosystem and backed by a group of industry experts across banking, fintech, and risk management. CGAP, a global partnership of more than 30 leading development organizations, will also give their input on how open banking/data can advance financial inclusion. Finally, we give the last word to our favorite African fintech writer Samora Kariuki, founder of Frontier Fintech.

Join us as we explore with our contributors a wide range of topics including the role of regulators, the potential for radically increasing financial inclusion through open banking, and the emergence of new business models powered by the free flow of data. Finally, each one of our contributors will give their prediction of how they see open banking shaping the African fintech ecosystem over the next few years.

Executive Summary

1. First-principles thinking vs legacy thinking

In part 2 we noted that Open Banking is both an opportunity and a threat to incumbent financial service providers. This is especially true in Sub-Saharan Africa, a significant amount of the continent’s banking services are being provided by smaller banks, MFIs, and Saccos that do not have the technical infrastructure to leverage consumer data in a way that will lead to the development of data-driven banking products.

Updating core banking systems have been compared to open-heart surgery and few financial institutions have the appetite or technical capabilities to build the modern banking infrastructure required to operate in a truly open banking environment. As such we envisage the continued proliferation of API infrastructure companies to accelerate as they play an increasingly important part in the continent’s fintech ecosystem.

“Our Product Bankone digitizes and completely automates the operations of Financial Institutions including core banking and back-office operations. The services are rendered via the cloud on a SaaS model requiring very limited investment in infrastructure and expertise on the part of subscribing Financial Institutions. The fully API-enabled platform provides the framework for MFIs, SACCOs, Neo banks, and tech-savvy Institutions to launch financial products in an agile fashion. Our platform provides the core infrastructure these nimble Neo-banks and Fintechs are using to create and roll out their innovative niche products very rapidly.”

Mudiaga Umukoro — CEO, AppZone Core

While Appzone is helping update core banking infrastructure, Mono, on the other hand, is redefining how data flows:

“Our core value proposition is to change the status quo for how customer data can securely flow from banks to fintechs with the consent of customers. This changes the relationship between these three entities by creating a healthy competition between banks and fintechs, fostering a stream of innovation between banks and fintechs, and ultimately, increasing trust between fintechs and their customers.”

Jennifer Onwudiwe — Product Marketing & Communications Manager at Mono

It is important to note that these fintech infrastructure companies are equally beneficial to incumbents as well as fintechs:

“We effectively give banks the ability to offer fintech services (become a neobank) and we offer fintechs the ability to utilize additional data and insights that will power their existing services and create new ones. The outcome for consumers is greater financial access and better products tailored to their needs.”

Brendan Playford — CEO, Pngme

2. Incumbent banks — A change of mindset

However whilst the rise of fintech infrastructure start-ups is equally beneficial to incumbents and disruptors, this is only the case where incumbents have a mindset that is conducive to accepting the changes coming in the data ecosystem. We discussed in part 2 how incumbent banks face the risk of becoming obsolete to customers if they do not reposition themselves well for a free data environment.

Traditionally, banks have had total control over all the customer data they collect allowing them to be the only source for traditional banking services such as lending and investment products. It is this moat that incentivizes banks to offer loss-making services such as free accounts in order to capture the primary customer relationship. As such it is understandable that senior leadership at banks may be reluctant to embrace policies that on the surface may seem to delete the banks’ incumbent data advantage.

However, in many ways, banks have the most to gain by embracing open banking standards:

“Banks traditionally have relied on the competitive advantage of owning their customers’ data. But in reality, they actually only own a fraction of their customers’ data because most people in African markets are multi-banked and use a high number of financial wallets, fintech apps, and other services. The true insights that will aid underwriting come from the data acquired in the Venn diagrams of the various financial touchpoints that provide malicious loan stacking information, loan hopping information, 360° views of debt-to-income ratios, etc. These insights are lost without an open architecture.

Thus, for banks, open banking relinquishes a sense of supposed data ownership but allows the bank to become highly innovative with acquisition and with ways to increase value throughout a customer’s lifecycle. Ultimately, a better understanding of a customer or market is more powerful than data ownership. This shift in perspective is currently creating as much resistance in banks as it is acceptance of the opportunity; a double-edged sword. “

Brendan Playford — Founder, Pngme

In previous editions, we highlighted that one of the biggest barriers to banks fully embracing open banking may be the mindset of senior leaders who have been brought up in a closed-loop ecosystem and have invested significantly in the status quo:

“Path dependence is where previous investments determine how future investments will be made. Many bank executives still want to sweat out the investments in “channels” done over the last 5 or so years.”

Samora Kariuki — Founder, Frontier Fintech

The answer may be for incumbent banks to launch new entities with separate management teams:

“I see banks moving towards having a digital version of themselves where the propositions are more tech-centered, and where that branch of the company has a different CTO and CEO i.e GT Bank, Zenith Bank, etc.”

Mima Benson Aruna — Program Manager, Open Banking Nigeria

3. The role of the regulators

We commented in previous editions that the regulator played an instrumental role in the proliferation of open banking in Europe whilst in stark contrast the US banked open system thrived in a market where the regulator adopted a more laissez-faire approach to regulation. In Africa, we are likely to see different approaches in different markets driven by the underlying competitive structure.

In South Africa, the customer is primarily owned by the banks and the top four banks control almost 80% of the market. In Kenya, the customer is owned by the telcos where most financial transactions are done on the mobile phone. Nigeria on the other hand has a litany of banks and we have recently seen an explosion of neo-banks catering to the gen-z and millennial customers.

Samora of Fintech Frontiers succinctly compares what has happened in Europe and the US, and the relationship that banks have with the consumers to what we see happening in the 3 major innovation hubs in Africa.

“European markets in both UK and continental Europe have a big 4 type banking market where 4 or 5 big universal banks dominate the banking landscape. Given this dominance, it makes sense for regulators to insist on data sharing so that niche propositions can be built by third parties but powered by the data sitting inside banks. Nonetheless, the US, for instance, has thousands of banks all serving specific niches such as banking the military, banking small businesses in Chicago, etc, and thus a regulator-driven model can’t work. In South Africa, you have big four dynamics and thus this approach may work there. In Kenya, a big 4 dynamic is slowly emerging though far from being like the one in Europe. That being said, M-Pesa throws a spanner in the works given that it’s the financial interface for most Kenyans. Nigeria doesn’t have a big four dynamic as well. It thus doesn’t make sense even from a macro perspective to have regulator-driven models.”

Samora Kariuki — Founder, Frontier Fintech

However, we believe that in the vast majority of the markets in Africa there can be no progress without at least a minimum amount of regulatory involvement.

“The general trend we have observed is that voluntary-led approaches have been less successful than mandatory ones.”

Ariadne Plaitakis — Senior Financial Sector Specialist, CGAP

In Nigeria, the regulator has adopted a more light-touch approach to open banking by publishing a regulatory framework of how banks should go about sharing customers’ financial data.

“The CBN’s approach has been more collaborative than prescriptive. They have relied significantly more on the industry and on Open Banking Nigeria. In other countries, however, open banking has been top-down either as regulations or laws.”

Mima Benson Aruna — Program Manager, Open Banking Nigeria

Meanwhile, in Kenya, the Central Bank of Kenya (CBK), has prioritized open infrastructure in its 2021–2025 strategy. The policy paper states, in part that “CBK will facilitate the development of industry-wide standards for open but secure APIs in a way that guarantees access, safety and integrity of data sharing systems. These standards will include API specifications for identification, verification, and authentication; customer account information/data access; transaction initiation; and formats and coding languages for APIs. Due to the risk associated with opening up data from financial institutions to third parties, CBK will define clear risk management frameworks and standards, including providing clarity on liability and consumer protection.”

Reading between the lines it seems that the CBK is looking to be more prescriptive than their Nigerian counterparts. Meanwhile, we would expect the Egyptian regulator to gradually move in the same direction albeit at a somewhat glacial pace. The CBE recently launched regulations that allow customers to make instant payments across accounts on their mobile devices. A small but important step in giving consumers control of their banking and data.

“The central bank and the Financial Regulatory Authority have both upgraded their regulatory framework to be more accommodating for digital payments and fintech firms,”

Sherif Samy, chair of the Egyptian FinTech Association and non-executive chair of the country’s largest private-sector lender, Commercial International Bank.

In time we expect clearer guidance on common API standards for KYC, data sharing, transaction initiation, and risk management. Given the top-heavy nature of the Egyptian banking system, once the regulator puts their weight behind open banking the market could quickly go from the laggard of the African open banking environment to the lead.

4. Financial Inclusion

Ultimately whilst infrastructure firms, neo banks, forward-thinking incumbent banks, and regulators all have a part to play in the proliferation of open banking standards the biggest driver will be consumer demands. This has been the case across Europe, the US, and Asia, and in many ways, Open Banking will play an even more critical role in SSA markets.

Today across the continent a significant proportion of the population is still financially excluded, for example over 36% of Nigerian adults are still financially excluded, and an even far greater percentage are excluded from borrowing due to thin KYC and credit data files. Financial exclusion has a big impact on a country’s GDP. Research from Ernst & Young shows that broader access to banking, savings, and lending products could boost GDP by up to 14% in large emerging countries such as India and up to 30% in frontier economies such as Kenya.

Central banks across the continent have tried with limited success to push funding to the SME space. Incumbent banks in Nigeria, Kenya, and Egypt have had a long-term preference for lending to government institutions and large corporations and have consistently failed to meet lending targets to SMEs. The challenge is that banks have been unable to utilize all the information they hold nor access data being held by other banks, telcos, and alternative data sources. As such bankers have been unable to accurately price risk when lending to thin credit file SMEs.

“Banks are sitting on a lot of data and don’t necessarily provide the products that benefit the unbanked or the underbanked, and that’s where fintechs come in. With open banking, it’s easy for fintechs to go to places where banks have overlooked, and by doing so financial inclusion is advanced.”

Mima Benson Aruna — Program Manager, Open Banking Nigeria

“Open banking would allow lending companies to build a more robust credit scoring system for their customers so they can price their loans accordingly. The liberation of customer data definitely levels the playing field for digital/neo-banks. In the past, digital banks leveraged technology to make banking operations more efficient but they didn’t have enough data. With the advent of open banking, digital banks are now able to better compete with the incumbents. One example comes to mind. A digital bank can now offer an overdraft to a customer based on their transaction history with an incumbent bank. Customers no longer need to have a track record with the neobank if their neobank can get their existing data.”

B54

Whilst liberating customer data from multiple banking sources will significantly enhance incumbents and emerging fintechs ability to price risk the real holy grail is moving from a closed banking eco-system to an open banking system and then ultimately an open data system where a far wider set of data points are made available.

“Open data, which is basically access to data that’s not even in the financial sphere that can support a financial digital data trail. So that could be things like social commerce, utility data, telecoms data, but not mobile money. So the general telecoms data, such as the usage of your phone with airtime plans, etc.”

Ariadne Plaitakis — Senior Financial Sector Specialist, CGAP

Open banking infrastructure firms, such as those highlighted in this report can help financial institutions both fintechs and fintech-enabled incumbents serve a far wider base of customers by making better use of transactional data to drive accessibility to financial services and much more personalized and cost-effective products for all types of customers. The resultant explosion of financial inclusion is the biggest reason why we are so excited by the open banking/open data revolution that we see coming over the next 3–5 years.

5. Predictions

From our interviews, the companies we spoke to had predictions of what is likely to happen in the next 3 years. Below are their predictions:

_{A) Mudiaga Mukoro, CEO at Appzone (BankOne)}

• In the next 3 years, most consumers of banking services will be very comfortable banking with Neo Banks and will have active bank accounts with at least one.
• In the next 3 years, the concept of Platform Banking will gain more prominence with more banks partnering with third parties in delivering financial products to end customers on digital marketplaces that may not necessarily be owned by the bank. Mortgage and Insurance products will lead the pack.
• In 3 to 5 years, I think more than 50% of banks in Sub Saharan Africa will have conformed to open banking standards and be delivering services to their customers through channels powered by Open Banking. Interestingly, I think around the 5-year mark, there will be close to 100% adoption of open banking in the region.

B) Jennifer Onwudiwe — Product Marketing & Communications Manager Mono

• The rise in Open Banking (API) adoption in other fintech services: More companies will find it easier to emerge and build as the layer that powers their ideas and products already exists.
• Increased crypto and digital currency proliferation: Crypto-based financial services will become more widely relied on and adopted.
• More enabling regulatory standards: Nigeria and the rest of Africa will perhaps be launched into more inclusive, collaborative, and enabling regulation for the fintech ecosystem.

C) B54

• More competition among FinTechs: More fintechs can get started because there would open banking would give anyone the ability to view people’s transactions.
• The emergence of the fintech super-app: Popular FinTech apps would eventually offer all financial services (banking, insurance, asset management) for their users because they now have data that allows them to underwrite peoples’ money needs.

D) Brendan Playford — CEO, Pngme

• The obvious prediction is increased access to credit for ‘thin-file’ customers due to improved access to financial data. This will connect banks to invisible primes and drive financial inclusion
• There will be an increased ability to provide Finlit and Credit Karma type share-of-wallet services via open data. This will provide a single view of accounts across different banks, which will give visibility to spending patterns and ultimately allow consumers to budget and save more effectively.
• Consumer-focused regulation will drive more confidence into the market as bad actors are better identified and good actors are nurtured towards prime by all stakeholders.

The detailed interviews can be found below: Here are the links to the interviews:

AppZone, Mono, B54, Pngme, Samora Kariuki, CGAP, and Open Banking Nigeria.

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