Will fintechs replace Nigerian banks?

I recently got my tires pumped last week at one of the roadside mechanics close to my house. Thanks to my poor planning, I only realised after my car had been fixed that I didn’t have enough cash to pay for the service. A couple of years ago, before the blow-up in the transformation of financial services, that would have been a huge problem, especially in Nigeria, where cash is still king.
 

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The onslaught of new entrants such as disruptive fintech startups and even telcos that have started using SIM technology to provide financial services has fundamentally changed this equation. I like to think about the disruption in financial services (or fintech) as simply innovation in services. To break things down further, we can group the four main jobs to be done in finance as follows:

• Payments: moving money from one location to the other in exchange for a good or service

• Credit: moving money from tomorrow to today

• Savings: moving money from today to tomorrow

• Wealth management: protecting the long-term value of assets

It’s important to set things out this way because when people think about financial inclusion in Nigeria, it’s easy to assume the useful metric is just to think about the number of people with access to a bank account. However, as stated above, financial services are much more than that.

The disruptors in the space are looking to solve problems in at least one of the four jobs to be done. As a result, new alternatives are now available to the part of the population previously underserved by traditional financial institutions such as banks.

Going back to my encounter with my mechanic earlier, I made it out of the pickle because while my mechanic did not have a bank account, he did have a wallet with a well-known fintech startup. These kinds of wallets allow users to complete transactions (such as paying to fix your car!) with just a valid phone number and email address. A few days ago, we discussed how decentralised finance (DeFi) is disrupting the credit space and what the impact would be on banks, the financial intermediaries in the current status quo. Today, I want us to consider the same question, but with payments.

To do this, we will unpack in more detail what the opportunity for startups solving the payments problem is in Nigeria. This will give us a sense of the current gaps in helping Nigerians pay for goods and services. From this, we can paint a picture of who is better poised to solve these problems: fintechs or banks?

In other words, should banks be worried about fintech startups when it comes to providing payments, especially consumer payment services?

Payments are on the up

By now, it should be no secret that the fintech vertical is the darling of the African tech ecosystem. In turn, payment is a big part of fintech. As you can see from the chart below, fintech continues to dominate in terms of share of funding into the Nigerian startup ecosystem. Furthermore, within the fintech space, payments and remittances top the charts (43%) in terms of the number of startups operating among the different sub-verticals.This is not surprising, as payment firms (within the broader fintech space) have traditionally been responsible for by far the largest share of international funding that has flowed into Nigeria’s fintech industry.

Payments are the largest and most sophisticated of the four core function fintech areas in Nigeria. For starters, we have seen Nigeria’s largest unicorn—Flutterwave (valued at $3 billion in 2022), and the first large exit (Paystack was acquired by Stripe for over $200 million in 2020) from this space. This sub-vertical has been bolstered by favourable regulations over the last decade, particularly in the form of the Central Bank of Nigeria (CBN) deploying a cashless policy and financial inclusion initiatives. Fintech has also been embedded in government policy in recent years. For example, beneficiaries of the Federal Government’s TraderMoni scheme, a lot-interest microloan program, were required to use Eyowo. This digital payment gateway helps users spend, receive, and send money using a mobile phone.

The policymakers’ motivation is clear. Going back to the World Bank database I referenced earlier, while access to bank accounts has increased for Nigerians, it’s clear that the financial needs of Nigerians are not fully met by any one channel. It’s easy to see why this is the case. Traditional banking is an expensive ordeal, typically requiring branches in target areas. Stears has highlighted some factors driving banks’ aversion to serve a larger proportion of Nigeria’s population. The low population density in rural areas and the high operating costs associated with running a physical bank branch make it hard for banks to expand their services to many Nigerians. So even for the population that might have bank accounts, the absence of a nearby physical branch to conduct their transactions from can make traditional banking services unappealing.

Of course, this does not discount banks’ efforts to offer digital services as an alternative to setting up physical locations. For example, First Bank of Nigeria Holdings (FBNH) established an electronic banking service to house its agency banking business, Firstmonie. In addition, Access Bank has reportedly grown a 100,000 agent network to deliver mobile banking services. All of this signals that the different market actors attempting to broaden the reach of payments services do not only include disruptors but also incumbents.

In addition, Nigeria’s financial inclusion levels have struggled to make much headway. According to Enhancing Financial Innovation & Access’ (EFInA), 17 million adults are not currently making electronic payments but own phones and are interested in mobile money. Another 22 million adults are not currently interested in making electronic payments but say they could be convinced to use it.

This brings the total addressable market for fintechs to at least 39 million, highlighting the market opportunity in this space. With this knowledge of the kind of activities the incumbents and fintechs engage in to solve payments, how worried should banks be?

The road to payments is paved with good intentions

To answer that question, we need to unpack the options available for providing payment services in Nigeria. A key thing to note is that (almost) everything is built on top of banks. That is, the payments system in Nigeria is bank-led. In Nigeria, the naira you hold or own is issued by the central bank and is recorded in a bank (or as cash). Contrast that with a country like Kenya, where payments are telco-led, given mobile money dominance.

This setup determines the shape that payment services take on.

For one, the bank-led model means that many fintech disruptors actually find Nigeria’s payments landscape to be relatively more sophisticated than other markets. For example, Nigeria has a real-time interbank payment infrastructure, NIBSS, that allows funds to be transferred between bank accounts within minutes. In addition, Nigeria’s payments system is well known for its interoperability (I can use my Access Bank account to send money to my sister, who banks with Zenith). By contrast, countries like South Africa are only gearing up to launch their own similar systems later this year. This level of sophistication offered by the traditional banking system has caused many to cast doubts over the potential for disruptors (startups and telcos alike) to provide a viable alternative to what traditional banks currently offer.

But this has not deterred fintechs from building competing solutions onto the existing bank-owned payment infrastructure for customers who may be unserved and underserved by banks. 

Now, it is important to clarify the different levels of solutions that fintechs offer when it comes to digital payments. Payments are usually classified along consumer-to-consumer, consumer-to-merchant, and merchant-to-merchant (otherwise known as B2B payments). Today’s fintechs play in either one or multiple of these spaces.

One example is Bankly, a fintech that offers digital payment solutions for service delivery businesses such as electricity distribution companies that face cash transaction leakages. With Bankly, these companies can create payment integration systems. Think of firms like the Ariaria Market Energy Solutions, a Special Purpose Vehicle (SPV) formed by three companies to serve rural areas without electricity access. These companies need efficient ways to collect electricity tariffs or need to prevent their officials from shortchanging the business when they receive cash payments.

By partnering with companies like Ariaria, Bankly can deliver even more value by collecting payments from the electricity firm’s customers—both banked and unbanked. In exchange, Bankly gains transaction commissions. It’s a win-win scenario because currently, the services offered by traditional banks are not necessarily customised to suit the needs of companies like Ariaria.

However, this does not mean fintechs can go the distance alone. Payment collections (in this case, consumer to merchant) are still powered by payment infrastructure, which requires a well-dedicated team of developers and strong contacts within NIBSS.

One useful example here is PiggyVest, which has been a savings and investment app until recently. In the first few years of its existence, the fintech had to partner with banks to store deposits (keeping customer funds) and open financial accounts or digital wallets for Nigerians. But these activities (hold funds) are not payment solutions. 

To pivot into payments, PiggyVest recently acquired PocketApp, which aims to tie a savings or investment wallet to a social marketplace. A PocketApp user can take the money they have been saving in their PiggyVest wallet to make a large ticket purchase directly from the PocketApp. This is a very niche use case for payments and is one that a bank might not be nimble enough to pay off. This drives home the point that fintechs tend to innovate for niche payment use cases. However, to do so, they rely on the core payment infrastructure owned by NIBSS (or banks, basically). As is common with startups operating in the financial services space, a licence is required for these services (in this case, a mobile money operator licence).

The CBN requires fintechs or other financial institutions (OFIs) to have one out of six licences to provide payment services.  

Most fintechs partner with banks to deepen the services they offer and have to share revenue with the banks. Other fintechs have gone for a full-fledged digital bank strategy (e.g. Carbon, VFD) so they can offer more than just pure-play payment services such as transfers, airtime purchases, and bill payments. This positions them to earn revenue from other banking services, most especially lending. To do this, obtaining a microfinance bank licence is required, which allows these fintechs to double down within payments. These MFB licences typically cost between ₦20 million to ₦5 billion. This can be restrictive. For instance, having an MFB licence that provides a limited range of financial services in only one state of the country costs ₦1 billion—almost $2 million—which represents a significant portion of the funds most fintechs raise at their seed levels.

This leaves the option of obtaining licences to operate either as a Payment Service Bank (PSB) or a Mobile Money Operator (MMO). But of the cost of licence acquisition and restrictions, you can immediately see that fintechs might not aspire to own these banking licences. Rather, they will gravitate towards the 'payment licences' under which the MMO falls. 

Fintechs with MMO licences still need to cough up at least ₦2 billion, while the minimum capital requirement for a PSB licence comes in at a whopping ₦5 billion. 

Attaching to survive

As a result, the current regulatory landscape still prevents fintechs from being the primary issuers of financial accounts (all banking licenses give the right to issue financial accounts). With the payment licenses, fintechs are left to settle for—PTSP, Super Agent, PSSPs—the role they end up playing is simply to facilitate the movement of money between financial accounts. But even that process requires an integration with the infrastructure for account-switching (from a Zenith to an FBN or vice versa). As I mentioned earlier, that infrastructure in Nigeria is NIBBS. If fintechs can't connect to NIBBS directly, they route their transactions through banks that already have access.

For new fintechs coming into the market, that presents significant hurdles such as the waiting period before NIBSS integrates them onto the service. To bypass this, many fintechs end up partnering with banks for an indirect connection to the payments infrastructure. As a result, banks can still get a cut from all the traffic flowing to the fintech.

As such, for the Nigerian scenario, it's very difficult to imagine fintechs, especially startups focused on payments, to ever really replace the banks. With the current status quo, banks continue to enjoy a first-mover advantage, which further entrenches their relevance even as challengers continue to find ways to innovate.

Overall, the ability for fintechs to completely unseat the incumbents largely depends on regulators’ willingness to go the distance in lowering the barriers to entry for non-bank players in the space. Ultimately, that decision should be based on an attempt to form an objective view of who can produce better results for the long-term health of the payments industry.