Massimo Young Reports from Kenya: The Surprising Secret to Banking Success

My good friend Massimo Young recently moved to Kenya, where he is seeing what happens when you mix a little American ingenuity into a thriving but chaotic developing economy.  In what I hope is the first of many blog posts, Massimo reports on just what it takes to succeed in the banking industry in Kenya.  (Massimo does not have a financial interest in any of the companies discussed in his post, although he wishes he did!)

M-PESA: The Story of the Most Successful Bank in Kenya
By Massimo Young 

It’s not easy to do business in Kenya. Business people complain all the time that despite a wealth of opportunities, there are often major roadblocks to accomplishing much on the ground, especially at scale. In fact, Kenya ranks 121^st out of 185 countries in the World Bank’s “Ease of Doing Business” survey.

On the other hand, there are some amazing examples in recent years of businesses that have managed to accomplish a lot very quickly. In particular, the wild success of mobile banking in Kenya has changed the way people use money here. Launched just 5 years ago, Kenya’s leading mobile money transfer service, M-PESA, now processes a total of about $5 billion in transactions per year, equivalent to an astounding 15% of the country’s GDP. Before it launched, only 14% of Kenyans participated in the formal banking sector. Today, about half the adult population uses M-PESA.

(Photo: Development Planning Unit University College London)

So what’s the secret to being the most successful bank in Kenya, where it’s supposedly so hard to do business? The answer is: not being a bank! M-PESA is not operated by one of the many domestic and international banks here, but rather by Kenya’s largest telecom, Safaricom.

At first, I thought the M-PESA story was a classic case of disruptive technology taking over an old-fashioned sector, like Netflix and Blockbuster. But talking to some people in the banking industry, I heard a different version of M-PESA’s success story – a story of monopoly, bad regulation, and government capture, producing a highly profitable but low-quality financial product and little competitive pressure to make it better.

Apparently, as mobile phone usage in Kenya began to skyrocket in the early 2000s, some banks started to offer mobile banking on mobile phones. But it didn’t work. Most of Kenya’s population lives in rural areas, and most bank branches are in cities, so there was no way for most people to conveniently deposit money. At the time, the only legal way for banks to reach these potential customers was to set up more branches, which was too costly. So mobile banking didn’t really take off.

Enter Safaricom. When M-PESA launched in 2007, Safaricom, which is partially owned by the telecom giant Vodafone, was far from a disruptive upstart. Rather, it had three enormous advantages over the banks, which it still has today. First, it had huge market share in Kenya. Second, it was not regulated as a bank. Third, it was 35% government-owned.

When M-PESA hit the market, Safaricom’s huge market share meant instant access to millions of customers. Monopoly power also allowed Safaricom to price out competitors with similar technology, like the banks, by charging them prohibitively high prices to do mobile banking on Safaricom phones. Most importantly, perhaps, was that because Safaricom was not a bank, it didn’t have to worry about bank regulations.  So to solve the problem of distribution, they outsourced deposit and withdrawal services to commissioned third-party agents who, in turn, could recruit sub-agents of their own. This proved to be a cheap way to set up tens of thousands of agents all over the country, making M-PESA a practical option for Kenya’s rural populations.

Of course the banking industry argued that Safaricom should be regulated as a bank– after all, it was performing basic banking services and investing users’ deposits. Instead, in 2010, when M-PESA already had about 15 million users, an amendment to Kenya’s Banking Act allowed banks to hire third-party agents. But unlike Safaricom agents, bank agents have to comply with a series of bank agent rules and be individually approved by the Central Bank of Kenya, which means it’s still pretty costly for banks to reach rural customers.  The banks are pushing to revise these rules and “level the playing field,” but for now, with over 45,000 M-PESA agents countrywide, M-PESA’s dominance seems untouchable.

In short, Safaricom figured out how to act like a bank without actually having to be a bank. By acting like a bank, they were able to serve customers who clearly demanded basic banking services. By not actually being a bank, they avoided the regulations that made it so hard for real banks to reach new customers. Monopoly power and government capture enabled them to maintain this advantage and keep competition low.

On the one hand, M-PESA is clearly a great achievement for the Kenyan consumer: millions of people who had no access to any kind of formal banking now perform basic banking services directly from their mobile phones. On the other hand, Safaricom’s near monopoly on mobile money means sky-high prices, little incentive to innovate, and a limited range of services to customers.  To transfer and withdraw the equivalent of a few dollars, users have to pay about 60 cents USD (higher amounts are cheaper but keep in mind that Kenya’s per capita income is about $850 per year). On top of that, M-PESA doesn’t offer much else besides transfers, like savings accounts with decent interest rates, loans, or insurance that a traditional financial services firm could provide.

M-PESA is an amazing example of a fast-growing and extremely successful business in Kenya, and it has inspired a whole slew of related businesses as well as a growing tech sector in the country. But the idiosyncrasies that led to its success make it seem like a tough feat to replicate, and perhaps not quite the engine of innovation it’s sometimes made out to be.