Disruptive Innovations or Enhancing Financial Inclusion: What Does Fintech Mean for Africa?

• Author: Alade, Isa

TABLE OF CONTENTS I. INTRODUCTION 676 II. THE AFRICAN FINANCIAL INCLUSION OR EXCLUSION CONUNDRUM 683 III. BEHIND THE LOW FINANCIAL-INCLUSION NUMBERS 686 A. Illiteracy and Financial Literacy 686 B. Identification Requirements 689 C. Historical Legacies, Culture, and Religious Beliefs 690 D. Poverty, Unemployment, and the Cost of Financial Services 693 E. Credit-Scoring Benchmarks 695 F. COVID-19 and Cashless Policies 698 IV. FINTECH PRODUCTS FOR AFRICANS 699 A. Alternatives to Conventional Credit Scoring Methodology 699 1. Using Customer Ratings in Determining the Credit Worthiness 700 2. Social Reputation Score Instead of Conventional Credit Score 702 3. Assessing Borrowing Capacity Depending on Phone Usage 703 4. Membership of Recognized Organizations as an Alternative Credit Measurement 704 B. Non-Internet-Based Products 705 1. Unstructured Supplementary Service Data as Connecting Basic Phones to the Platforms of Financial Institutions 706 2. Mobile Money as the Most Prevalent Fintech Product in Africa 707 3. Telephone Numbers as Account Numbers 708 4. Point of Sale Terminals 709 5. Airtime as Currency of Exchange 709 C. Innovative Authorization or Verification Protocols 710 D. Blockchain Technology 711 E. Cryptocurrency 713 F. Central Bank Digital Currencies 716 V. THE REGULATORY APPROACH TO FINTECH IN AFRICA 719 A. Emerging Approaches to Fintech Regulation in Africa 719 1. Test-and-Learn Approach 720 2. Experiment-and-Facilitate Approach 720 3. Laissez Faire or "Wait-and-See" Approach 722 4. Technology-Neutral Approach 722 5. Incorporation or Technology-Specific Approach 723 6. Prohibitions 723 B. Constraints on Effective Regulation of Fintech in Africa 723 1. Path Dependency Constraints 724 2. Misalignments with Financial-Inclusion Policy 726 3. Inappropriate Regulatory Strategy 729 4. Ambiguous and Overlapping Regulations 729 5. Impact of Cross-Sectoral Legislation 731 6. Lack of Convergence 733 7. Burdensome Licensing and Regulatory Frameworks 734 C. Transforming Legal Rules for Fintech in Africa 736 1. Determination of Regulatory Objectives 736 2. Regulations Targeting Financial Inclusion 737 3. Investment in Financial Education 739 4. Redesigning Consumer Protection 741 5. Re-evaluation of Creditors Protection Framework 742 6. Intra-African Integration Arrangements 743 VI. CONCLUSION 744 I. INTRODUCTION

After September 11, 2001, and the 2008 global financial crisis, the world witnessed unprecedented turns in regulating financial services. Suddenly, financial services regulators imposed a series of anti-money laundering and counterterrorism financing (AML/CTF) rules and know-your-customer (KYC) rules on financial service providers. (1) During this period, there have been endless discussions about capital-adequacy requirements, prudential regulations, understanding systemic risk, and working with "too big to fail" financial institutions towards minimizing risks to the global financial system. (2) Such conversations indicate that world leaders acknowledge the need to set standards at the global level and to expect cooperation and harmonization. (3) Naturally, regulators in Africa, along with the rest of the world, have adopted such regulations in an attempt to fight against money laundering and terrorism financing, and to collectively ensure global financial stability. (4)

While the focus was on important financial institutions, however, innovation in financial services did not stop. Cryptocurrencies, online/mobile banking, robo-advisory services, alternative credit rating systems, and many other technological innovations facilitating the delivery of financial services started to challenge regulators and the existing regulatory structures all around the world. (5) In the last decade, the number of fintech companies operating globally has skyrocketed, and the value of investment into fintech firms has reportedly exceeded $1 trillion. (6) In 2021 alone, over $210 billion was invested globally in fintech companies, an enormous increase from the $14 billion invested in 2015. (7) Africa has shared in this remarkable growth trajectory: investment in the fintech sector in Africa doubled from $800 million in 2020 to $1.6 billion in 2021. (8)

Despite the rise of investments in fintech, financial services in Africa remain inaccessible to a large segment of the population, particularly vulnerable groups including women. (9) About half the adult population of Africa still lacks at least one form of bank account, and financial exclusion persists even in the largest economy on the continent--Nigeria. (10) A variety of socioeconomic factors, including the widespread lack of acceptable identification documents and credit history, as well as illiteracy, poverty, and cultural/religious beliefs, have made accessing the most basic financial services a monumental task for several people in the continent. (11) To put this in context, the World Bank reports that more than half a billion individuals residing in Africa--the majority of whom are women--do not have an acceptable form of identification document. (12) The implication is that such individuals cannot easily access financial services from conventional financial services providers due to stringent requirements around identification documents. However, as this Article shows, with fintech products and suitable regulations, there is now a chance to provide financial services to hundreds of millions of unserved and underserved people residing in the continent.

The focus of fintech in most developed economies is primarily to disrupt the existing traditional financial services offerings through the deployment of innovative technologies to generate better efficiencies. (13) For example, commercial transactions were historically conducted using fiat currency, operating through financial intermediaries like banks. (14) The emergence of private cryptocurrencies like Bitcoin, Ethereum, and Litecoin created virtual digital systems that facilitate payments without the need for a traditional financial intermediary--a disruption of the fiat currency framework. (15) Moreover, cryptocurrencies are designed to enable commercial transactions that bypass banks and reduce or eliminate related consumer costs such as transfer fees, credit card fees, and currency exchange fees. (16) Cryptocurrencies may therefore seem like a disruptive technology for the well-established banking systems of the developed economies since it cuts out the financial intermediaries from the payment processes.

In Africa on the other hand, cryptocurrencies may instead facilitate commercial transactions for people who historically do not receive services from traditional financial intermediaries such as banks. (17) To continue with the example of cryptocurrency, since financial intermediaries are not currently able to serve a very high number of financially excluded people, cryptocurrencies would not be regarded as disruptive but actually creating or building an entirely new payment system. Rather than taking business and customers from banks in the continent, the rise of cryptocurrency may well be providing a valuable financial service to many people for whom such services are not otherwise available.

As we show in this Article, the growth of fintech in Africa is driven significantly by an unmet demand for financial services. (18) Certain fintech products flourished in African countries due to their ability to promote access to financial services. For instance, while technology-based credit platforms gained prominence in developed economies, it is mobile money that reached unprecedented levels of usage in African countries. (19) Mobile money, a service that was pioneered through M-Pesa, enables unbanked individuals to perform various financial transactions using a mobile wallet maintained through their mobile phone. (20) Even though access to traditional banking services remains challenging for most Africans, the wide availability of mobile phones has allowed millions to conduct financial transactions through mobile money services--by 2020 there were about 1.21 billion registered mobile money accounts globally, of which 548 million (about 45 percent) were in sub-Saharan Africa. (21) There are eleven countries in sub-Saharan Africa where a larger share of adults only have a mobile money account rather than a bank or other financial institution account. (22)

Beyond mobile money, the African financial services industry has witnessed several other unique fintech products that address specific challenges to financial inclusion such as alternative credit scoring technology, non-internet-based financial products, and digital currencies (private and government). (23) In short, fintech is clearly being utilized to build a new financial services industry in its entirety across several African countries. (24)

African countries recognize the potential that fintech holds for financial inclusion, as well as the need for regulation in this space. In Africa, financial inclusion lies at the heart of fintech regulation. The central banks of both Nigeria and Ghana, for instance, specifically spell out financial inclusion as an objective. (25) On the other hand, while developed economies acknowledge that fintech can deliver financial services to financially excluded populations, enhancing the offerings of such products is not a priority for developed economies. (26) This is simply because developed economies have already achieved a high rate of financial inclusion among their citizens, and there are widely available alternative financial services offerings in these markets. (27) For example, the Bank of England expressly acknowledges that financial inclusion does not fall directly within its regulatory remit. (28) This variance is also noticeable in international financial regulations where policy objectives like financial inclusion are not given critical attention. (29) This means that the policy objectives of...