ELECTRONIC mobile money is now the preferred currency in many developing countries. This poses significant economic and monetary policy risks, says Abdi Ali.
When a central bank prints money, it becomes trusted and it is this trust that allows people to accept this money in exchange for goods and services.
The two most important functions of money are (i) store of value – the value of money is fairly predictable over a period of time and does not generally become worthless or unusable overnight; and (ii) a medium of exchange – people hold money to swap something they need with it. For instance, someone who has one US dollar can expect for the value of that dollar to be fairly stable and use it to buy something costing one dollar.
These functions of money in turn support the financial system – the system which makes money work by bringing depositors and borrowers together. Through financial system intermediation, money borrowed can then be used for productive economic purposes – for instance investment that creates jobs. Money and financial system thus become intertwined.
This is why a country’s central bank keeps a close eye on whether country’s currency is functioning as intended and if the overall financial system is safe, resilient and operating well.
The problem with mobile money
Electronic Mobile Money (EMM) is not real money and does not perform the generally accepted functions of money. EMM’s store of value depends entirely on whether the people who use it trust the company operating it, rather than the government issuing the currency. If people lose trust in the EMM operator, everything in the EMM wallet could become worthless overnight and cannot be exchanged for goods or services.
Second, EMM provides a limited medium of exchange in so far as it can only be used in a particular country, location or accepted by few merchants, unlike actual currency which can be used/exchanged almost anywhere. There is no consumer protection if operators fail to repay their customers, nor is there a central bank that can back it to maintain the currency’s local / global market confidence.
Third, EMM operators’ impact on the overall resiliency of the financial system is another significant risk. The lack of interoperability of the system (allowing different EMM operators to accept and clear payments from one another) means a significant proportion of a country’s financial system relies on one or a few operators, posing unacceptably high risks to a country’s entire economy.
If one operator were to have significant market share, unpredictable and sustained cash outflows would lead to liquidity risk and eventually failure. For instance, a recent World Bank estimate put the annual EMM transaction value in Somalia to be more than $32bn a year, roughly 650 percent of the country’s entire Gross Domestic Product. Many other developing countries face similar systemic risks.
Fourth, there is the issue with monetary policy. If an EMM operator outside of a regulatory perimeter were to issue electronic money which is not backed by actual currency, it would impair the central bank’s ability to operate the country’s monetary policy levers.
Fifth, economic openness and innovation also suffers. EMM operators that enjoy market dominance by virtue of the lack of interoperability will be less inclined to innovate, securing bad value for consumers in the longer term. As a consequence, the entry barrier for new operators also becomes prohibitively expensive, thereby reducing market access for challenger operators and limiting consumer choice, further increasing systemic risks.
The point is not only about the systemic risks but also the wider adverse implications for the economy, innovation and market competition.
Regulating operators to innovate
The points just highlighted are some of the key reasons why the perceived beneficial impact of EMM, in widening access to financial services, is not only overstated but also are outweighed by other material risks.
In my view, the answer is not to regulate EMM operators out of business, nor is allowing them to operate outside of the constraints of a well-functioning regulatory system the solution either. There are three ways these risks could be mitigated through prudential risk management policies, market access and monetary policy frameworks.
Prudential risk management
The issue about liquidity risk is too material to be ignored. EMM’s profit model depends entirely on the free use of customers’ term liquidity (i.e. the liquidity benefits derived from the time it takes to deposit into the wallet up to the point when physical cash is eventually taken out). This in turn incentivises excessive risk taking – the investment of customer funds into illiquid assets, thus exacerbating liquidity risks.
The solution is to mandate currency-for-currency matching of customer funds held at the central bank and a customer guarantee scheme to compensate in case of operator failure. Operators should be allowed to levy nominal charges when a customer’s overall monthly transactions exceed a limit set by the central bank. This will protect the viability of the business model and ensure the currency’s medium of exchange function is protected.
A regulatory condition threshold principle would also need to be applied to avoid telecoms becoming quasi-banking institutions without the attendant regulations. Relevant thresholds should be set beyond which telecoms become banks or non-bank financial institutions. This will help in mitigating the risk of EMM operators outgrowing their regulatory permitter vis-à-vis the risks they pose to the financial system.
As EMM operators increasingly become systemically important in many developing economies, especially in Africa, the question of how to make them fail safely becomes even more pressing. Central banks need to start thinking about a resolution regime which ensures these companies can fail without taking down the entire economy with them. The starting point is to shift the risks to the owners of these companies through a regulatory process which sets out solvency, adequacy of the risk management and financial resilience requirements.
EMM operators dislike the idea of interoperability because the cash settlement of funds between different operators will work to limit their ability to use the free liquidity that sustains their market dominance. It also means challenger operators, who may offer better services, are excluded from the market, and other non-telecom businesses could face competition from the same EMM operator(s) using significant free liquidity to expand to other markets. The overall level playing field of a country’s economy becomes tilted away from competition to monopoly.
The requirement for a full interoperability between operators, either through a central bank settlement system, or one set up by the industry with central bank oversight, would mitigate this risk. Furthermore, giving customers the right to transfer their mobile phone number and transaction history freely across operators would increase the system’s resilience and lead to increased market competition and innovation. It also means account aggregator companies will be able to use the customers’ transaction histories to develop consumer credit market, opening up the country’s financial market to greater innovation.
A well-functioning financial system with low entry barrier and increased innovation would benefit everyone.
This is a risk that is particularly acute in Somalia (and indeed in other countries that may not have a functional central currency). If private companies can issue electronic money which becomes acceptable as a medium of exchange, confidence for using the currency rests with the private company, rather than with the central bank, thereby making the role of the central bank redundant. The Somali government’s reluctance to reform the “Shilin” and move the country away from dollarization is instructive.
As a consequence, the central bank’s monetary policies, such as managing the aggregate flow of money in the economy, fighting inflation and supporting the value of the local currency become significantly impaired. This makes it imperative for there to be close regulatory scrutiny over the issuing and backing of the EMM.
In many African economies, EMM operators are now domestically important financial service providers and will continue to be part of Africa’s financial services landscape. Understanding the risks they pose and bringing them into a proportionate and effective regulatory system will be vitally important for a safe and stable financial system.
Abdi Ali is the Head of Group Funding & Liquidity Risk Assurance at Swiss multinational investment bank and financial services company UBS in London. Abdi has an interest in how new forms of financial technologies are dramatically changing the industry through digital and alternative financial platforms, and the implication this has for banking.