Cash and mobile banking can be sound proposition in emerging markets

IT WOULD seem odd to put the two together: cash and mobile banking. But the strange bedfellows make a good business model for expanding into banking in emerging markets.

A McKinsey report this week showed that in cash-based economies, mobile banking providers can significantly raise profitability by ramping up the number of digital transactions each time cash is put into the system.

The reality is that cash is not going away in this markets. McKinsey pointed that even in Norway, 17 per cent of all payments are transacted in cash. There are also concerns that a fully cashless society further marginalises those who are not part of the banking system. This is a significant risk in emerging markets.

But the helpful bottom line that McKinsey offers is that it is not a lost cause. Even if there are more cash transactions, the costs can be lowered if more digital transactions are made off those funds.

The fat margins on transactions - as high as 75 per cent in certain emerging markets - make this pursuit worthwhile, as the large fees are weighed against the low costs to the provider using automated systems and digital user interfaces, the consultancy estimated.

McKinsey pointed out that as digital payments allow people to transact in small amounts, they also create new business models. Digital payments enable a pay-as-you-go model, where consumers pay for a customised usage. Financial firms can also charge consumers payments for services such as school fees and health care, as well as wages.

Servicing the underbanked

Grab certainly views these developments positively. It announced this week an expansion of its financial services in South-east Asia to the underbanked in the region. It has tied up with Japan's Credit Saison to offer working capital loans, and consumer goods financing, among other things, to its Grab drivers, agents and merchants.

Grab will ride on its 2017 acquisition of Indonesia's Kudo, an e-commerce company that uses a physical agent network to sell products listed online for a commission.

Trying to remove the costs and constraints of brick-and-mortar, this "online-to-offline" business model tries to fit a digital retail concept to a cash-based society.

Kudo, according to reports, has about 50,000 agents in 500 Indonesian cities and suburban districts earning cash by selling fast-moving consumer products - such as soap and shampoo - listed on online platforms.

Kudo's model thus tries to tackle the digital gap between rural and urban areas in Indonesia, an archipelago comprising more than 17,000 islands.

Grab now wants to tap into this network to provide financing to consumers. What makes this strategy clearer is that it has also partnered Indonesian conglomerate Lippo Group to tap into a wider consumer base.

The move comes as larger companies - from banks to large technology companies - are more likely than smaller players to expand successfully into emerging markets through mobile banking because of scale, McKinsey said. Fixed costs from information technology to marketing expenses can keep a small fintech in the red for way too long, especially in cash-based markets.

In cash-based economies, customers must be able to efficiently deposit and withdraw cash into and from their payment accounts. Many mobile banking players rely on agency networks - either hiring third-party sales representatives, or drawing on an existing retail network - to ensure that customers can get access to cash, or deposit funds.

So a digital-only banking approach in South-east Asia can work at its optimum if the financial services firms tie up with large local consumer players, giving them immediate access to a larger - and constant - pool of customers.

Stephen Bates, partner at KPMG Singapore and head of deal advisory for financial services, told BT recently without referring to specific deals that winners in a digital banking strategy would need to align with consumer giants such as supermarkets or the large conglomerates to build a network quickly.

Untapped opportunities

What adds to the attraction of mobile banking is that there are untapped opportunities in the area of data-based financial services, and micropayments.

There are some hopes that new ways of credit assessment through real-time data on regular consumption spending can offer a new form of credit risk assessment. For example, Grab wants to use its extensive customer database to provide an alternative means for measuring credit ratings.

To be sure, these ongoing pursuits of expansion through a digital banking approach are at early stages.

Grab, for example, has noted that its US$737 million in loans - mainly for vehicle financing - have a low default rate of less than 1.5 per cent, but it is not clear how this default rate would change once other forms of consumer loans come into the mix.

McKinsey principal Olivia White, who co-authored the McKinsey report, told BT this week that digital banks have to monitor the effectiveness of agency networks.

If agents end up just mainly signing up digital customers without offering banking transactions that generate revenue, then the agency network means a hefty cost burden, too.

Still, there are some growth opportunities to be pursued in emerging markets, even as cash is still king in these regions. There are risks, but for banks and other incumbent services that must seek bigger growth outside saturated markets - with Singapore as a prime example - this emerging business model for financial services in Asean should be watched with care.