Investment in DFS: Heed Legal Frameworks and Ecosystem

Afi-Global, an alliance of central banks and financial regulators, defines Digital Financial Services (DFS) as a broad range of financial services delivered through digital channels, including payments, credit, savings, remittances and insurance, as well as mobile financial services. In this instance, “digital channels” refers to the internet, mobile phones, ATMs, POS terminals, electronically enabled cards and other digital systems.

The Ethiopian banking business proclamation recognizes DFS as “financial services including payments, remittances, and insurance accessed and delivered through digital channels.”

The 2019 amendment of the proclamation was the first to recognize digital financial services within the scope of banking. This approach confines DFS to the elements of ‘banking businesses’ – not something separate.

However, the specific legal definition in the proclamation refers to ‘all digital financial services including…’ alluding to a non-exhaustive approach. Unlike the brick-and-mortar banking business, digital financial services are less exhaustive, making it difficult to include all possible ‘digital financial services.’

The bright side is that this open-ended approach could provide ample opportunities for broadening both services and investments in and around DFS. In addition, the non-exhaustive definition could also stimulate innovation, entrepreneurship and a dynamic ecosystem.

Technically speaking, DFS is legitimized by the legal recognition of electronic units of money (e-money). Transactions commence after backing the e-money generated and stored by real currency in a trust account.

Regardless of who backs the money and stores it, DFS is predominantly delivered through a collective of participants. Hence, investment in DFS solutions is inevitably investment in a cog of an elaborate machine. 

Unlike in other ventures, revenue from investment in DFS depends completely on maintaining a successful end-to-end transaction process in the ecosystem. A payment system operator that wants to integrate various payment outlets will not be profitable unless all the services are functional and the payment accepting party is seamlessly integrated.

Digital financial service providers do not depend solely on a single component of the ecosystem, be it telecommunications services or agents, to convert cash into e-money, store and transfer payments. That is why any investment will inevitably be influenced by the other investments made in the ecosystem.

For instance, the success of Safaricom’s M-PESA is attributed to 604,000 agents across six African countries providing mobile money services to 51 million active customers. It processes over 300 billion transactions a year. This is a result of low-value, high-volume transactions achieved through an extensive agent network.

In a domestic case of success, Hello Cash, operated by three financial institutions, announced it recorded transactions worth 100 billion Birr in the last year. The achievement is largely due to high-value transactions made by 2.5 million active Hello Cash subscribers.

Telebirr, owned by Ethio telecom, recorded 21 million subscribers and 30 billion transactions as of June 2022. Its performance is not necessarily directly tied to the state-owned enterprise’s 64 million telecom customers or to Telebirr’s subscriber base.

The investment and transactional success lies in turning Telebirr’s subscribers into active users by expanding digital financial services such as access to saving, micro-lending services, utility bill payment, e-ticketing, and remittance.

This argument is evidenced by comparing Telebirr’s annual transaction of 30 billion Birr to HelloCash’s 100 billion Birr. The disparity is the result of the latter’s ability to convert subscribers into active users rather than the number of subscribers. 

However, the ease of customer onboarding for telecom-based service providers is undeniable and might lower customer acquisition costs compared to other service providers.

The introduction of directives that, for the first time, distinguish between the banking industry and digital financial services are a significant milestone for potential investors.

In practical terms, investment options are broadly classified into two despite the non-exhaustive list outlined in the banking business proclamation. Investment in DFS can be made as a payment instrument issuer or a payment system operator.  

The former refers to issuance of electronic funds (cash-in, cash-out, micro-credit, and micro-insurance) while the latter deals with operating systems (technology).

Investments that qualify for licensing/permit include banks, microfinance institutions, insurance companies, payment instrument issuers, and payment system operators. The payment system operator category is further broken down into national switch, switch, ATM, POS, and payment gateway operator subcategories. Investors can choose to apply for one or multiple licenses under payment gateway operator as long as the minimum capital requirements are met.

Although DFS is closed to foreign investors, their engagement in the sector is already visible in both classifications, although limited to system provision.

This alternative strategy drives viable business agreements between foreign technology providers and domestic issuers through revenue sharing, commission collection, or selling technology.

The mobile banking technologies of M-birr, CBE-Birr and HelloCash are products of these arrangements.

Except banks, any entity licensed in DFS is designated as a ‘financial institution’. The broader definition opens space for independent licensing of DFS.

While DFS is not exclusive to banking, in light of broader definition and separate licensing, the service falls under the banking industry. That is why restrictions on foreign banks or investors remain applicable.

However, foreign investors shouldn’t be discouraged by the restrictions as alternative partnership strategies have proved fruitful in the past and will continue to do so until the limitations are removed, for which there is ample hope.

The government recently amended the National Payment System proclamation, which the Council of Ministers has forwarded to parliament for legislation. It provides a new definition that was missing from the previous proclamation of 2011.

It stipulates that digital financial services include the issuance of payment instruments; processing of payments; provision of micro-credit, micro-savings and remittances, which are determined from time to time by the National Bank and delivered through digital channels.

It also defines DFS providers as banks, payment instrument issuers, payment system operators, or any other non-bank financial institution that receives a license from the National Bank of Ethiopia. This clearly demarcates between the banking business and digital financial services.

If approved by parliament, the amendment will signal a new era for local and foreign players operating and hoping to engage in DFS.