Financial systems support livelihoods by providing access to savings, payments, lending, insurance, investments and credit assessment for individuals and households.

Financial inclusion remains a challenge in emerging markets typically because of a non-enabling environment created by the regulators, such as central banks, securities and exchange commissions and telecom authorities, and low interest among commercial banks in the long-tail customer.

Pakistan is fortunate because it has forward-looking regulators. Over the past 20 years, they have kept pace and, in some cases, got ahead of the industry. Regulators can create an enabling environment that not only allows non-bank players to provide solutions but provide customers a redress mechanism, data protection and trust. Lack of interest among commercial banks for the non-banked customers and limited capital for fintechs are not a regulatory issue and need to be addressed commercially.

The State Bank of Pakistan (SBP) took the lead in 2002 by issuing separate prudential regulations for microfinance banks. This was revolutionary as few countries had created separate regulations for this segment. Parties could establish a microfinance bank with a capital of Rs1 billion as opposed to Rs10 billion required for a commercial bank. A microfinance bank could take deposits from any individual or corporate but had restrictions on the loan amount, and could lend only to individuals below the tax net. As a result of this regulation, there are now 11 microfinance banks in Pakistan. They have 3.3 million active loan customers with a portfolio of Rs220bn. The deposit customer base is 53m with total deposits of Rs300bn. The Economics Intelligence Unit rated the SBP’s microfinance regulations among the top five globally.

Lack of interest among commercial banks for non-banked customers and limited capital for fintechs are not a regulatory issue

Of these forward-looking regulations, the force multiplier for the financially excluded was the branchless banking (BB) regulations, which were issued in 2002 jointly by the SBP and the Pakistan Telecommunications Authority (PTA). The BB regulations enabled any bank to partner with a telco. This was revolutionary as the banking industry has a limited branch network and the branch coverage drops drastically in rural areas.

The BB regulations allowed banks to utilise the telco agent network as banking service points. Suddenly, the ability to deposit, withdraw and transfer money increased from 13,600 to 400,000 locations. However, the unique BB agents are about 80,000. BB agents don’t play golf on Sundays, are located in neighbourhoods, have long working hours and are well-represented in rural areas. BB regulations have provided the much-needed relief to the masses for basic financial transactions.

Although the BB agent network greatly assisted the unbanked for domestic remittances, utility bill payments and loan repayments, this remained a cash-to-digital-to-cash transaction. This meant no new money came into the banking system. The SBP then issued a level zero and then the Asaan Account regulations. A level-zero account can simply be opened by sending an SMS to a telco-owned bank or a commercial bank which has third-party payment provider integration. Leveraging on the fact that Pakistan has a universal identifier (CNIC), which can be verified in real time from Nadra and that all holders of SIM cards have biometric identification made the fully verified account opening possible under a minute. A level-zero account allows Rs25,000 daily activity, Rs40,000 monthly activity and a maximum balance of Rs200,000 at any one time. This regulation allowed the number of mobile wallets to reach 55m. While this a laudable number due to lack-of-use cases, the number of active users is low.

The SBP then realised that for optimum financial inclusion it would need to utilise the customer base of popular apps that are not a bank. It initially came up with a payment service provider and payment service operator licence and approved 14 applicants in principle but only four became operational.

Looking to further harness the non-banked population, it issued the electronic money institution (EMI) regulations. Now a non-bank can create an open-loop wallet, pre-paid cards and contactless payment solutions. Imagine the likes of Messenger, WhatsApp and TikTok using their railroads for payments. In order to protect customers, EMI licence-holders must keep the customer funds in an escrow account with a scheduled bank. Given the rather high regulatory licence requirement of Rs200m, the SBP has precluded innovative start-ups to benefit from this opportunity. Given that the funds are placed in an escrow account, the SBP should revisit this requirement.

The Securities Exchange Commission of Pakistan (SECP) has been another star as far as the enabling environment is concerned. It first provided the much-needed regulatory support to microfinance entities operating under different regulations by creating the non-bank microfinance regulations but its initiatives under its sandbox have stolen the show. The SECP created a sandbox and about 35 applicants applied. For its first cohort, the SECP chose a digital broker, a Shariah-compliant general insurance company, equity crowdfunding, debt crowdfunding, digital platform for mutual funds and robo-advisory. As regulations do not exist for any of these activities, the SECP will create limits, safeguards and will monitor the activity for the next few months.

The intention is that based on the findings of this first cohort, full-blown regulations will be issued after six months. Digital brokerage and digital life/general insurance will not only bring in new products but completely change the customer journey for on-boarding and more importantly the claim process.

Equity crowdfunding could become an important source for start-ups, but has its own challenges. Equity crowdfunding combined with tokens can bring house ownership to the masses. Debt crowdfunding will need to be monitored closely due to the debacle of the lending club in the United States and the recent scandals related to this mechanism in China. Both the mutual fund platform and robo-advisory are a welcome addition as there are less than 50,000 individual brokerage accounts.

Published in Dawn, The Business and Finance Weekly, December 7th, 2020

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