Learning Theme 11: What ecosystem improvements will unlock investment in digital finance? is one of 16 learning themes designed to address a range of questions within the digital finance space. The FiDA Partnership synthesizes and disseminates the digital finance community’s knowledge of each of these learning themes into “Snapshots” that cover a number of client, institution, ecosystem, and impact level topics. The Snapshots give a current view of “What We (in the digital finance community) Know” about the topic in question, highlight “Notable New Learning” and call attention to “Implications” for future research and investment.
Why we wrote this Snapshot
One of the persistent challenges to the growth of digital finance is underinvestment. Investment plays a key role in extending digital finance to hard-to-reach customers and can encourage disruptive, innovative solutions. The digital finance community and investors can learn from the experiences of mobile money and branchless banking services, often the first point of exposure to digital finance for a mobile-enabled but unbanked population. However, even the foundations of these aforementioned services have been underinvested. Mobile money services have become the access rails to other DFS innovation, but the underinvestment has had a knock-on effect to both the commercial and social impact potential of digital financial services (DFS).
Snapshot 11 provides a comprehensive overview of how investment can foster the development of digital finance ecosystems, the challenges the industry faces in raising the necessary investment, and the roles of different types of investors.
What we found
A combination of stringent regulatory environments, internal constraints faced by service providers, the lack of the appropriate technical infrastructure, and the absence of diverse financing options in emerging markets all contribute to the fact that digital finance has yet to receive the investment required for sustained growth.
Mobile money services have primarily focused on rapidly reaching scale—in almost all cases through high volume and low value transactions. This is because profitability has typically been based on earning small margins on large volumes. However, reaching this level of scale requires a lot of capital; indeed, setting up a mobile money service can be prohibitively expensive. Partly because of these high operational costs, it can be difficult to obtain the green light to invest the large amounts of funding necessary to bolster and maintain mobile money infrastructure from senior decision makers at mobile operators or financial institutions.
The focus on acquiring a critical mass of customers conducting low-value transactions has led to infrequent use of digital finance, mainly in the form of monthly payments discussed in Snapshot 1: Which financial needs can and should be addressed by DFS? However, providing customized solutions (i.e., more sophisticated DFS products) or a tailored product suite responding to specific customer needs can actually propel the number of transactions per customer by encouraging more regular use of DFS products. Thus, such customization has the ability to increase the provider’s revenue, perhaps justifying the needed investment in mobile money services. Although the industry has seen a slow move towards sophisticated products, such as FIBR’s work in Tanzania and Ghana, a lack of funding and technical infrastructure is holding growth back.
Another big challenge to investment in digital finance has been the lack of capital generally available in emerging markets. For example, in 2016 African start-ups disproportionally relied on founder capital while venture capital (VC) and angel investment only represented 12% of the total pool of funding invested across all African tech start-ups. FinTechs seem to be struggling to attract the appropriate funding from VCs. Many VCs seem to have made a strategic decision not to invest in African markets. Perhaps this decision is to be expected from VCs that have not operated in emerging markets before, as they could see the patchy or underdeveloped and protective intellectual property laws in some African markets as a deterrent.
This is not to say that emerging market FinTechs are not as credentialed and committed as their developed market counterparts; there is increasing evidence to suggest that they are. However, capital deficits and a dearth of mentors to support their capacity hinder emerging market FinTechs. So too, the relatively lower penetration of smartphones in emerging markets compared to developed markets restricts access to the consumer-level data on which FinTechs often rely to build their services and products. This may add an additional layer of concern for VCs that have hesitated to deploy capital to African FinTechs. This Snapshot finds that emerging market start-ups often function in ecosystems that are less networked, less funded, and generally less supported.
Read Snapshot 11 to go deeper on the topics above and learn more about the unintended consequences of philanthropy in the sector, the role various investors need to play in order to spur the financial development of digital finance in Africa, and the top-10 reads in the space this year.