Branchless Banking: Rapid Growth Poses Regulatory Challenges

Basic, everyday financial services are out of reach for more than two billion people in developing countries. But the rapid growth of branchless banking - which combines technology with retail channels - is reducing the cost and increasing the availability of such services.

As has happened in advanced economies, branchless banking is now changing the way people get financial services worldwide. In the past five years, Brazil has brought 13 million people into the banking system. Technology powered that explosive growth. In the Philippines, people would rather pay 1 percent to remit money via their mobile phone network than the 3-18 percent they are often charged by others.

While much of the current buzz is around mobile phones, other branchless banking applications are gaining traction as well. Brazil's increase in access to finance has been accomplished largely through the more than 95,000 banking "correspondents"--local merchants and post offices that act as agents for banks, equipped with card-swipe and barcode-reading point-of-sale (POS) terminals. In Russia, a broad network of bank ATMs, POS terminals, and online e-money providers offers transaction services outside of traditional branch offices.

Regulating growth
This innovation presents challenges and opportunities for regulators. Policy will determine not only where branchless banking is legally permitted, but also which business models are economically feasible and how far they will go in reaching poor people. A new CGAP/DFID Focus Note examines those issues. Regulating Transformational Branchless Banking: Mobile Phones and Other Technology to Increase Access to Finance is based on assessments of policy and regulation in seven key countries, including interviews with 531 people from government, the private sector, and international organizations.

"For regulators, it's not viable to simply do nothing. Current regulation tends to be both overprotective and underprotective," says Tim Lyman, CGAP's senior policy adviser and co-author of the Focus Note. "Being too restrictive can mean fewer people in the formal financial system and higher costs to access services. But policy makers also need to be aware of potential protection gaps."

Taking a proportionate approach
Among the countries studied, a surprising consensus surrounds the short list of the most critical topics policy makers and regulators should address to formulate regulatory policy for transformational branchless banking.

The following are two topics considered to be "necessary but not sufficient" preconditions:

• Authorization to use retail agents equipped with information and communication technologies as the "cash-in/cash-out" point and principal customer interface.
  
• Risk-based anti-money laundering (AML) rules and rules for combating financing of terrorism (CFT) (adapted to the realities of remote transactions conducted through agents).
  
• Four topics are considered to be "next generation" policy and regulatory issues. Though they may not prevent branchless banking from getting a start in a given country, they will figure in its success and sustainability as a means of getting financial services to the unbanked poor:
  
• Appropriate regulatory space for the issuance of e-money and other stored-value instruments (particularly when issued by parties other than fully prudentially licensed and supervised banks)
  
• Effective consumer protection (on a variety of fronts)
  
• Inclusive payment system regulation and effective payment system oversight as branchless banking reaches scale
  
• Policies governing competition among providers (which balance incentives for pioneers to get into the branchless banking business against the risk of establishing or reinforcing customer-unfriendly monopolies and which promote interoperability)

"In all these areas, regulators are best guided by balancing the costs and benefits against the objectives, a proportionate approach to regulation," says David Porteous of Bankable Frontier Associates, who was commissioned by DFID as a co-author of the Focus Note.

Protecting consumers
For branchless banking to reach its potential, consumer protection is essential. Issues include problems with retail agents, redress of grievances, price transparency, and consumer data privacy. Regulators should aim for policy that fosters, rather than inhibits, innovation so market participants are not unduly restricted from launching new financial products and services.

"Understanding risks and how providers might mitigate those risks is crucial for regulators," says Mark Pickens, CGAP microfinance analyst and co-author of the Focus Note. "Based on our research, regulators should avoid limiting the range of possible branchless banking models. They should dialogue with industry, but the private sector ought to have answers on how it'll ensure services are safe and sound."