By Adedeji Olowe and Ifunanya Ezeani
Either with technology or vanilla traditional finance, operating within the finance space in Nigeria, as in every country, is heavily regulated. Providing financial services without a license can be a criminal offense for some and definitely attracts heavy sanctions for all. It’s pretty simple — playing with someone’s money is like playing with someone’s life — you have to prove you know how to do it. Even when you prove you can do it, sometimes failure occurs — it is for this reason that the Nigeria Deposit Insurance Corporation (NDIC) was established in 1988 to engender confidence in the Nigerian Banking System and guarantee payments to depositors, in case of imminent or actual suspension of payments by insured banks.
As finance evolves and is driven with technology, regulators are slowly catching on: the Central Bank of Nigeria (CBN) has licensed switches, processors, payment service providers, etc for ages. But when it comes to hard-core digital finance, the apex bank still has some distance to cover. The Securities and Exchange Commission (SEC), Nigeria’s apex capital market operator, has also spent the better part of its 41 years of existence licensing traditional Capital Market Operators (CMOs) until recently when it switched up to fintech licenses.
The power of tech for finance is evolving so fast that there now exists a significant gap between what’s possible (fintech) and what’s permissible (licensing). This has led to the war between regulation and innovation. Who’s going to win? Not to give up, startups have increasingly turned to twisting and contorting existing licenses to fit what they want to do with the hope of either escaping the regulatory hammer or getting some modicum of legality.
If you think this is a little dramatic, consider the following real-life scenarios.
Digital banking
This is where a bank is 100% branchless and banking is done with web and mobile apps. With the increasing number of digital banks, one would have expected the CBN to roll out corresponding digital banking regulations. Unfortunately, no such license exists. So digital banks buy into the existing unit Micro Finance Banks (MFB) framework and then turn the new organization into a digital bank. Kuda and V Bank by the VFD Group are examples. Most digital banks in Nigeria operate under the MFB framework. These digital banks are exploiting the location limitations in these licences due to their branchless, digital nature while meeting the physical office requirements as allowed by the licence.
Investments
Investment tech such as Bamboo, Chaka, Rise Vest, and Trove have opened the eyes of Nigerians to the possibilities of snagging significant returns within the US capital market. And most have done this by leveraging the technologies provided by DriveWealth LLC while snapping up lucrative partnerships with Capital Market Operators (CMOs). Of course, knowing the danger of unbridled capital market play, the SEC issued a directive to CMOs to stop unholy alliances with these investment tech companies and even filed a restraining order against Chaka for operating outside the regulatory purview of the Commission. As a result, in April 2021, the SEC issued a Major Amendments to the Securities and Exchange Commission Rules and Regulations, 2013 making significant changes to the provisions relating to Sub-Brokers.
Payments (real-time transfer)
The ability to move cash from bank to bank is core to payments. And to do payments, you have to be connected to core switches like Nigeria Inter-Bank Settlement System Plc (NIBSS). If you ain’t a bank, you ain’t invited. Participants to NIBSS Instant Payments (NIP) include commercial banks, Micro-Finance banks (MFBs), and Mobile Money Operators (MMOs). Fintechs, especially the unlicensed providers, connect to NIBBS through commercial banks that route these last-mile transfers to NIP and Interswitch.
Deposit-taking/savings
The ability to take cash deposits and investments from the general public is limited to banks, finance houses, CMOs, and insurance companies; the lucky and licensed few. But this cash-taking is core to the business model of many fintechs such as PiggyVest and CowryWise. It more likely enhances their value offering by making it a one-stop shop for financial services. Take OPay’s Owealth and Flexifixed product for instance — as an MMO, OPay is not allowed to take investments. However, to enhance its value offering, OPay partnered with Blueridge Micro Finance Bank. While Blueridge MFB owned the investment product, OPay’s platform is used to reach out to OPay customers to subscribe to the investment product.
Insurance
Cassava, AutoGenus, and Aella App are popular InsureTechs in Nigeria, a space regulated by the National Insurance Commission (NAICOM) is the regulator of insurance in Nigeria. In 2018, NAICOM provided the guideline for Microinsurance operation in Nigeria, thereby theoretically making tech-driven insurance permissible. Although NAICOM increased the minimum paid up capital for insurance and reinsurance companies in May 2019, the increase did not affect Micro-insurance companies.
For Aella App, a lending and investment application company that ventured into insurance, its health insurance scheme, AellaCare, is offered in partnership with Hygeia Health Management Organization (HMO). Curacel also evolved from an e-health startup into Insurtech, by providing technology to insurance organizations to minimize fraudulent claims. For Insurtech, NAICOM has so far provided two clear paths- provide microinsurance or use technology leverage to partner with existing/traditional insurance companies.
License induced partnerships
Due to the huge capital requirements associated with licensing, most Fintechs who haven’t raised funds from VCs partner with existing licensees to run their services. The licensee owns the financial product while the fintech owns the tech. Instances abound where other payment companies leverage infrastructure and licenses in the form of partnerships with established players to power their platform.
How alliances in fintechs could be a disaster
While these alliances may have been good for the industry so far, it portends risks for the ecosystem. The reasons aren’t far-fetched: core pillars of financial stability are sometimes alien to the tech companies which then makes license repurposing a significant system risk ahead of everyone.
But clamping down on tech companies is an even bigger risk as the action would stall Nigerian economic growth. The burden is therefore on the regulators to create new categories of license with the necessary regulatory guardrails. If this isn’t done, there could be a systemic failure, resulting from the quest of tech companies to survive and thrive through alliances. To proactively ensure growth in the fintech ecosystem, it’s recommended that the regulators review the financial and time cost associated with licensing, adopt a new model, expand the regulatory net to crypto exchanges rather than mandating other financial institutions to desist from serving them, especially considering that blocking the cryptos doesn’t hurt them, it only makes them powerful enough to be more damaging.
Even where regulations exist, they contain requirements that make it extremely difficult, if not impossible, for the average tech company to take advantage. For instance, the capital requirements of N25 billion for a commercial bank license are definitely out of reach for most startups. So these startups flocked to the acquisition of Unit MFB license to allow them to offer savings, lending, and payment services. But with the devaluation in Naira and evolving realities of capital requirements, the CBN has hiked the minimum capital requirement for a Unit MFB from ₦20 million to ₦200 million, State MFB from ₦100 million to ₦1 billion, and a National MFB at ₦5 billion.
Even where a startup somehow manages to meet the capital requirements, the time it takes to get a license is a big factor. It takes months and even years for regulators to come to terms with license issuance, which is damaging to the growth of the ecosystem. Fintechs are like kids, impatient, so they scramble to find alternatives.
Reviewing the financial and time cost required to acquire a license would encourage more players in the ecosystem, increased competition, and innovation, employment potentials, simplification of financial services and financial inclusion, etc. Lest we forget, the Government makes a lot from taxes on transactions.. The regulator understands this, and to encourage fintech innovators, the CBN in July 2020 released a draft Framework for Regulatory Sandbox Operations aimed at establishing a controlled environment where disruptive technology in the financial services can be tested under the supervision of the CBN. Although this is commendable, its success will be determined by the implementation.
In summary, though the rationale behind capital adequacy requirements is to strike a balance between the operational risk and the actual risk-bearing capacity of the licensees, it can have a penal effect if it discourages innovation. License repurposing is an important consideration for tech ecosystem growth in Nigeria’s financial services landscape. Activities of licensed companies reviewed based on data made available to regulators could accelerate license repurposing or create a body of new licensing.