Law and Regulation of Mobile Payment Systems

Issues arising 'post' financial inclusion in Kenya

Joy Malala

• Publisher: Routledge
• Year: 2017
• eBook ISBN: 9781351728577
• Edition: 1
• Topic: Law
• Subtopic: Financial Law
• Index: Law

Over the last ten years mobile payment systems have revolutionised banking in some countries in Africa. In Kenya the introduction of M-Pesa, a new financial services model, has transformed the banking and financial services industry. Giving the unbanked majority access to the financial services market it has attracted over 18 million subscribers which is remarkable given that fewer than 4 million people in Kenya have bank accounts.

This book addresses the legal and regulatory issues arising out of the introduction of M-Pesa in Kenya and its drive towards financial inclusion. It considers the interaction between regulation and technological innovation with a particular focus on the regulatory tools, institutional arrangements and government decisional processes through the examination as a whole of its regulatory capacity. This is done with a view to understanding the regulatory capacity of Kenya in addressing the vulnerabilities presented by technological innovation in the financial industry for consumers after financial inclusion. It also examines the way that mobile payments have been regulated by criticising the piecemeal approach that the Central Bank of Kenya has taken in addressing the legal and regulatory issues presented by mobile payments. The book argues there are significant gaps in the regulatory regime of mobile banking in Kenya.

1 Problem and scope of the study

Introduction

‘A country’s payment system is what makes it real and financial markets work … when commodities are exchanged for cash, cheque, giro, credit card, or debit card payments rather than other commodities, trade expands as transaction costs fall and production specialisation increases.’¹

1.1 Background

In 2008, Kenya enjoyed stable growth within its banking sector, and it appeared to have avoided most of the ripple effects from the Global Financial Crisis.² However, despite the resilience of leading local retail banks in the preceding years, only 19 per cent of Kenya’s 40 million people had bank accounts in 2009.³ As is the case in many developing economies, banking is still widely considered to be the exclusive preserve of the rich, who can afford the regular and costly fees charged by banks whose branches were, and continue to be, few and far between.⁴ Until recently, there had been very little incentive for banks to serve the ‘unbanked’ and ‘under banked’⁵ members of society, principally, due to the significant costs entailed in establishing a network of regional branches and the minimal margins associated with providing banking services to the ‘poor’.⁶ Consequently, the adoption of mobile financial services, and in particular mobile payments, has become an effective step in the evolution of payment schemes.⁷ This has enabled the gap created by the lack of a broad financial infrastructure in Kenya to be narrowed.⁸

As a result, mobile payment systems have become commonplace in Kenya over the last 7 years⁹ through the introduction of M-Pesa¹⁰ by the leading mobile network operator (MNO) Safaricom Ltd.¹¹ M-Pesa, a new financial services model, has transformed the banking and financial services industry in Kenya by giving the unbanked majority access to the financial services market, and in the process, it has attracted over 18 million subscribers.¹² This is remarkable, given that fewer than 4 million people in Kenya have bank accounts. It has succeeded in transferring people from a cash economy to modern book entry systems. The annual deposit value stands at KSh. 93,273,000,000 billion ($932,730,000); withdrawals are KSh. 79,917,000,000 billion; and transfers are KSh. 84,882,000,000 billion, including KSh. 25,610,000,000 billion, from airtime values of KSh. 3,551,000,000 billion.¹³ Therefore, the significance to the Kenyan economy cannot be underestimated. Simple payment and settlement functions have been made even more convenient and accessible by this technological innovation in the payments system. Mobile payments have, to a large extent, achieved the policy objectives of financial access and inclusion, which have been part of the overall landscape of financial services and delivery in developing countries such as Kenya. Therefore, in order to understand the importance of this new financial service, this thesis aims to address some legal regulatory issues that arise out of this innovation as they pertain to Kenya, post-financial inclusion. Financial inclusion or inclusive financing is the delivery of financial services at affordable costs to disadvantaged and low-income segments of society. This is in contrast to financial exclusion, where those services are not available or affordable. The term ‘post-financial inclusion’ in this thesis will be used to describe the subsequent phase when financial inclusion has been achieved, a period through which a large portion of the population has access to finance and financial services and the rate of inclusion as begun to plateau.

1.2 Problem statement

Innovation and technology present an intersection between growth and development, which is also an intermediary between the innovators, on the one hand, and those that use the innovations, on the other. Innovation has also been seen as both transformative and catalytic for the way that a country’s most productive economic sectors develop. Innovation in this context will refer to both innovation in technology and in the financial products and services introduced. It should be clear that the concept of ‘innovation’ encompasses not only ‘technological innovation’, that is, the diffusion of new products and services of a technological nature into the economy.

However, it equally includes non-technological forms of innovation, such as ‘organisation’ innovations. It may be used interchangeably with the term ‘technology’, although clarification will be given as and when needed and in context.

This is particularly true in a developing country such as Kenya, a sub-Saharan African country whose private sector is still under-capitalised and under-developed.¹⁴ Innovation is needed and should be encouraged, as the private sector is the main driver of economic growth,¹⁵ a position adopted in development literature¹⁶ as well as in Kenya’s ambitious economic development plans, which seek to transform it into a middle-income economy by the year 2030.¹⁷

Furthermore, this thesis addresses the interaction between regulation and technological innovation from Kenya’s perspective, with a particular focus on the regulatory tools, institutional arrangements and government decisional processes through the examination of its regulatory capacity as a whole. This is done with a view to understanding the regulatory capacity of Kenya in addressing the vulnerabilities presented by technological innovation in the financial industry for consumers after financial inclusion. It also examines the way that mobile payments have been regulated by criticising the piecemeal approach that the Central Bank of Kenya (CBK) has taken in addressing the legal and regulatory issues presented by mobile payments.

This focus is used because many of the major obstacles to technological innovations in developing countries are related to the institutional and regulatory environment.¹⁸ Such obstacles are not fundamentally different from those experienced in the developed countries; however, they are exacerbated in developing countries and are more challenging to address, particularly because of the absence of a coherent regulatory system.¹⁹

1.3 Purpose

An effective payment system in which the transferability of claims is effected in full and on time is a prerequisite for any economy. Similarly, disruptions in the payment system result in disruptions in aggregate economic activity.²⁰ In general, payment systems can preserve or undermine the public trust and confidence in financial systems; thus, they are under close public policy scrutiny with a view to safeguarding financial stability and ensuring financial integrity.

Therefore, the purpose of this study is also to discuss the legal and regulatory issues that underpin mobile payments in Kenya by postulating that the protection of consumers and the stability of the financial system should be the main justification for government intervention by way of regulation. This is in response to the rapid adoption, speculation and optimism regarding the effects of mobile payments on economic development in Africa, where policy-makers have rightly touted the poverty eradicating potential of mobile payments due to their financial inclusivity.²¹

Since there is currently an increased focus on payments systems issues which reflect the political changes and economic development occurring around the world, this study aims to examine the legal and regulatory issues that mobile payments present.²² Despite the existence of other payments systems, such as electronic payments,²³ there have not been any other advances in Kenya’s payments system because it largely remained a cash dominant society and any other forms of payments systems had primarily been cheques, electronic funds transfers, automated teller machine (ATM) cards, and debit and credit cards until the introduction of mobile payments.²⁴

A number of unique and country specific factors have contributed to the success and acceptance of mobile payments, and these will be discussed in Chapter 2.²⁵ Among these are the wide availability and heavy use of mobile phones²⁶ because the telecommunications regulatory environment enabled faster adoption of mobile phone usage. In 1997, over 75 per cent of countries in sub-Saharan Africa had no mobile phone network. By 2009, a mobile phone network existed in every country, with 49 per cent of markets fully liberalised, 25 per cent partially deregulated and 26 per cent as monopolies.²⁷ The most common reason given for this increase is the technology in the market and the willingness of consumers to embrace new payment systems via mobile devices. In Kenya, many people are completely unbanked and so have no access to traditional bank accounts and financial services, because they lack a sufficient income to qualify for such services.²⁸ Establishing an efficient payment system is essential for the efficient functioning of competitive money and capital markets as well as monetary control. These are the prerequisites for the creation of a well-developed market-based financial system. Hence, the stability and efficient working of the banking system is tied to the integrity and resilience of the payments system, and disruptions in the payments system result in disruptions in aggregate economic activity.²⁹ Additionally, instability that manifests itself in the payments system can be seen as more alarming than instability in deposits.³⁰ This fear is manifest in the larger volume of daily payments within the mobile financial services and the speedy movement of the funds, as well as the unfamiliarity with the clearing process.³¹ Therefore, the payment system is one of the first places where financial stress is manifested, through the Herstatt Risk,³² as firms in financial difficulty fail to meet their payment obligations.³³ Moreover, there are very few theoretical, and even fewer empirical, studies which look at the fragility and risks of mobile payments systems, much less the payment systems as a whole in developing countries, especially in those countries that are trying to restructure their banking and monetary systems.

The theoretical framework that underpins this thesis is that, since innovation in financial services always outpaces regulation,³⁴ developing countries that adopt innovative products and services should have the regulatory capacity to do so. In order to advance governments’ financial inclusion agendas, regulators should have the capacity to regulate these innovative products and services in a way that protects those who might otherwise be left vulnerable in times of financial crises. This regulatory capacity³⁵ should be commensurate with their economic development, regulatory development and their regulatory objectives as a whole. This thesis asserts that regulatory authorities in Kenya should be equipped to provide appropriate and adequate regulation of technological innovation that takes into account the best approach that would justify and balance regulatory or state intervention. Further, this thesis will aim to discuss this adequate and appropriate approach by focusing on a risk-based and prudential approach to regulation. Such an approach focuses on the stability and integrity of the payments system and the financial system as a whole, and the conduct of the business approach...

Table of contents

• Cover
• Title
• Copyright
• Contents
• Acknowledgements
• 1 Problem and scope of the study: introduction
• 2 Introduction to the mobile payments system in Kenya: background and historical context
• 3 Financial stability and integrity after financial inclusion through mobile payments
• 4 The legal and regulatory challenges in the current regulatory framework
• 5 Themes around the appropriate regulatory framework for mobile payments systems
• 6 Conclusion
• Index