M-Pesa And GCash: Can ‘Lean Regulation’ Be A Gamechanger for Financial Innovation?
Guest post by Chris Bishko and Pearl Chan
Hang around Silicon Valley long enough, and you will hear about the “Lean Startup Approach,” a methodology developed by Steve Blank and popularized by Eric Ries. The Lean Startup Approach emphasizes scientific experimentation, validated learning, iterative product design, and frequent product releases to gain customer feedback so that entrepreneurs can innovate on observed – rather than on pre-supposed – customer needs.
Many prominent Internet software companies — including Intuit INTU -0.96% and DropBox — employ this philosophy and deliver strong results. However, we have been encouraged to see the Lean Startup Approach taking root in the world of “suit and tie” financial services regulation. We term this trend “Lean Regulation” where regulation is iteratively layered in as the market develops. We have observed this approach being applied more and more in emerging markets, and believe it has relevance to more mature markets as well.
Emerging economies could teach the developing ones a thing or two about mobile financial services innovation. For example, Kenya has witnessed the meteoric rise of M-Pesa (pesa is Swahili for money), a mobile money platform that was incubated at Vodafone VOD -0.81% and seeded with funding from the U.K.’s Department for InternationalDevelopment. Early on, Stephen
Mwaura, head of the national payments system, and his colleagues at the Central Bank of Kenya (CBK), adopted a Lean Regulation approach to working with M-Pesa. Through frequent dialogue with M-Pesa, and guided by its technical expertise, CBK took steps to mitigate key systemic risks, while still providing M-Pesa enough room to innovate, evolve and grow. For example, CBK executed an operational risk audit, as well as a survey of 3,000+ customers, which further increased the central bank’s comfort level.
Supported by this regulatory approach, M-Pesa thrived. In just five years, it now has 23 million customers (74% of adults in Kenya); and a whopping 31% of Kenyan GDP is now transacted through mobile money services. Moreover, there is emerging literature on the second-order benefits that this lean regulation approach has had on the Kenyan economy. Turbo-charged by the boon of mobile money, M-KOPA has been able to provide 25,000 rural Kenyan families with a safe, affordable solar light source that uses M-PESA to facilitate a pay-as-you-go feature. By providing an enabling environment for new financial services companies, lean regulation indirectly enabled the scaling of high-impact companies that now ride upon M-Pesa’s payment rails.
The experience is not unique to Kenya. In the Philippines, central bankers anticipated the mobile revolution in financial services early on, and proactively established two specialist units:
- One for technology that combined bank enforcement and information, communications and technology expertise; and,
- One for customer protection for new products.
Their foresight prepared them for a new non-bank-based mobile payments model, GCash, which emerged in 2004. The Philippine regulators took a pragmatic approach to engaging with GCash. In particular, Nestor Espenilla, Jr. deputy governor of the Central Bank of the Philippines (BSP), was open to collaborating with GCash due to the need for clarity about how anti-money laundering, know your customer rules, and potential consumer complaints should be applied to this emerging “mobile money” platform. Espenilla and his BSP team worked to manage the biggest downside risks, while still providing significant flexibility for the nascent mobile money platform. This included a “test and learn” approach, whereby the BSP provided emerging financial services providers with a letter of “no objection” for a pilot, after having thoroughly vetted the risks and benefits. GCash has since evolved into a global mobile money leader in Southeast Asia, reaching two million users, and stimulating other innovative market entrants, including Smart Hub, Inc., that are facilitating financial inclusion in the Philippines.
The examples of Kenya and the Philippines may lead some to believe that Lean Regulation works best in countries where most citizens are unbanked or underserved. Yet we also see the potential for both lean and smart regulation to benefit developed countries, including the United States.
In November 2012, the U.S. Consumer Financial Protection Bureau convened an event in Silicon Valley to spur innovation and collaboration between the government and financial services entrepreneurs. Director Richard Cordray articulated the US governments’ role in encouraging and supporting positive innovation, noting “we have found that regulators can often impede innovation…we clearly understand that innovators…often are the first to note new consumer needs and are faster to find new creative solutions that make consumers better off.” Could an era of Lean Regulation in the U.S. market be around the corner?
Although the success factors for M-PESA, G-Cash and other emerging market mobile money solutions have their own intrinsic drivers, our research and conversations with both regulators and innovators have revealed two recurring themes.
1) Dialogue. An open and collaborative public and private dialogue helps foster the trust and understanding necessary for regulators to provide financial service providers with the latitude to develop and scale breakthrough products. This was particularly important in both Kenya and the Philippines.
2) Layering in Regulation. Once they gain critical mass, new markets move and evolve rapidly. As more is learned from disruptive solution providers, it may be appropriate for regulators to develop rules based on observed market behavior and to introduce regulation iteratively (again, taking a “lean” approach). This “layering in” approach can reinforce and encourage an emerging sector, while at the same time still help to catalyze increased competition.
In some ways, it is surprising that financial services — an inherently digital sector that touches all of our lives everyday — has not been more dramatically reshaped by new technologies. Pessimists may agree with former Fed Chairman Paul Volcker ‘s gloomy 2009 evaluation, citing the ATM as the only significant financial services innovation that has materially improved people’s lives in the last few decades. We don’t. We assert that we are on the cusp of an exciting new era in financial services that is being ushered in by mobile, Internet and social networking technologies.
Square, Prosper, LendingClub and PayPal are just the beginning, and Lean Regulation that is responsible may help us get there even faster. To encourage the Apples, Googles, and Facebooks of the financial services world, we should consider thinking creatively, like the regulators in Kenya and the Philippines. A Lean Regulation approach that prudently mitigates areas of greatest risk, while still providing room for innovation, could yield significant benefits all around. In a world where affordable space travel, self-driving cars, and 3D printing are within our grasp, our ability to “reimagine” traditional financial services should be similarly unbounded.
Chris Bishko is an Investment Partner and Pearl Chan is an Investment Associate at Omidyar Network, an investment firm created by eBay founder Pierre Omidyar and his wife, Pam. Omidyar Network is committed to creating and fostering opportunity for people around the world. The authors would like to thank the various contributors who made this blog post possible.