Interview: Aftab Ahmed; Cecilia C Borromeo
What are the next steps to accelerate the transition into a digital financial system?
AFTAB AHMED: Digitisation is transforming the way individuals and businesses access financial products and services. The transition to digital is enhancing efficiency and security while also contributing to greater financial inclusion. This is particularly relevant in the Philippines as a sizeable percentage of the population remains unbanked and does not have direct access to banking products and services. The government is already undertaking several policy initiatives to further improve banking access among underserved populations, such as improving the ability to send or receive payments and remittances, and widening access to basic transactional accounts.
A great example of the focus on digitisation is the launch of the Philippine EFT System and Operations Network (PESON et), which is a batch electronic funds transfer (EFT) payment stream that enables same-day, full-value transactions. PESON et is the first automated clearing house (ACH) under the National Retail Payment System (NRPS) framework.
The NRPS is a very important part of the Bangko Sentral ng Pilipinas (BSP) programme aimed at transforming the country’s payments system and increasing retail e-payment transactions. As of mid-May 2018 more than 40 banking institutions had already signed up to promote this central bank initiative.
The growth of the NRPS will require strong engagement and involvement by member banks to bring about an interoperable ecosystem that allows for seamless EFT between bank accounts. The second ACH, InstaPay, which was also launched in April 2018, enables transactions of less than P50,000 ($988) to be made in real time.
According to the 2014 Consumer Finance Survey, 86% of households do not have a deposit account. This means that only 14% of the population saves their money in banks. The government and the private sector have the opportunity to address this gap through greater collaboration. A key opportunity to promote broader adoption of digital solutions is the development of telecoms infrastructure to make remote banking more accessible. Additionally, there needs to be more emphasis on financial education.
CECILIA BORROMEO: The most important step is related to the reach and speed of telecoms infrastructure. The central bank has been very progressive in looking towards the possibility of using financial technology (fintech) to reach more unbanked Filipinos. Banks are willing to do more, and we are aware of the systems that can help us reach this goal; however, internet connectivity is lagging, so we cannot optimise the use of these available systems.
UNG: There are multiple prerequisites to facilitate the progression from a cash-based ecosystem to digital. The lack of a national ID is one major obstacle to on-boarding customers in a cost-effective manner. Without it, the know-your-customer (KYC) costs will continue to be a hindrance to financial inclusion.
In addition, there needs to be more recognition of the costs associated with cash handling, reconciling, safekeeping, depositing and disbursing, along with the contingent costs of losses from theft, pilferage and human error. Otherwise, payers will weigh the costs of electronic payments against convenience, while ignoring the costs of cash handling.
Lastly, an electronic payment ecosystem, comparable to cash in terms of universal acceptance and instantaneous settlement, is needed. The new Instapay automated clearing house created under the NRPS framework is a major step forward.
BAUTISTA: Increased collaboration between banks, regulators and innovators, such as fintech companies, will play a key role in accelerating the transition to a digital financial system. Historically, there were a lot of constraints that prevented banks from onboarding consumers into digital banking. In the past, banks would still need a brick-and-mortar branch for face-to-face KYC and cash servicing. Likewise, banks needed to contend with legacy systems – not to mention their legacy mindsets – in providing solutions. It was also costly to migrate a cash-based society to digital platforms.
Over the years, banks have been more concerned about managing their financial performance, rather than digitally overhauling their existing business models. However, their traditional model has been disrupted by the arrival of fintech companies, whose primary approach to quickly penetrating the market is to solve customer bottlenecks through innovation. Moreover, regulatory restrictions were the least of their worries. The main constraint on fintech companies is their limited access to the financial system due to lack of distribution networks and the trust of consumers. When there is collaboration, each major player brings a certain ingredient to the equation.
Banks have the infrastructure, distribution network and trust of the consumers, while fintech companies bring the innovative mindset and customer insights from outside the traditional banking model. We must help fintech companies accelerate some of their ideas and products, but at the same time remain vigilant so that we only extend our partnerships to responsible organisations. Of course, regulators will have to provide the middle ground to properly govern the digital financial framework, while promoting greater financial inclusion within the population. Ultimately, all parties need to work together in promoting financial literacy, security, data privacy and consumer protection.
In what ways is the collaboration between banks and the BSP already resulting in successful financial inclusion initiatives?
BORROMEO: The central bank is very supportive in terms of financial inclusion, particularly through the NRPS. Again, however, most of these new measures can only be implemented efficiently if we have the necessary telecoms infrastructure and better connectivity. ATMs in some provinces, where unbanked communities reside, have not been set up because of connectivity issues, and the two dominant telecoms companies in the Philippines do not have enough bandwidth to support all the institutions operating in rural areas, so I think this is a fundamental challenge that needs to be addressed.
UNG: The BSP has been very progressive and continues to support financial inclusion. Indeed, the central bank recently issued a new circular broadening the range of acceptable identification documents, as well as allowing restricted accounts with minimal KYC to access their services.
The BSP also spearheaded NRPS framework with the private sector, banks and non-banks alike, in the creation of the PESON et and InstaPay platforms. Both ACHs were established to improve connectivity and interoperability within the financial industry to minimise friction costs associated with electronic transactions, thus encouraging financial inclusion.
AHMED: The BSP has, over an extended period of time, embraced the ambitious goal of financial inclusion as a way to provide services to all Filipinos, especially the unbanked. With that goal in mind, the central bank has formulated an inclusion strategy, with the following four pillars: financial education, advocacy, data and measurement, and policy.
The central bank has also partnered with private banks to promote financial inclusion, including initiatives that encourage micro-entrepreneurship.
Greater collaboration between the government and financial institutions will not only address the issue of the unbanked, it will also lead to longerterm progress and further add to economic growth.
By bringing financial services within reach of all Filipinos, individuals and communities will be empowered to take advantage of economic opportunities that can help improve conditions among low-income households. Microfinance is one component of financial inclusion advocacy that can serve as a powerful tool in helping to reduce poverty. Access to financial services allows low-income individuals to pursue their entrepreneurial ambitions, develop an income stream to better support their families and create jobs within their communities. Micro-insurance is another important tool that can reduce the vulnerability of low-income households by protecting the livelihoods of the underserved.
BAUTISTA: On an industry-wide basis, there have been several components that the BSP has already put in place to encourage major industry players to move forward – all of which were introduced in consultation with the banking sector.
First, they worked on new regulatory frameworks to address hindrances in onboarding and account opening, particularly through the introduction of agency banking and risk-based KYC assessment. They have also mandated bank interconnectivity through the NRPS to make payments and fund transfers more efficient and less costly for consumers.
In addition, the central bank is leading the way in pushing the sector by encouraging sandbox projects and the use of cloud technology. Regulations are already in place for banks to lend based on flows, meaning they are no longer constrained by net income, assets or other collateral.
What are the most effective ways to decrease KYC costs and offer financial products to micro-, small and medium-sized enterprises (MSMEs)?
BAUTISTA: A typical MSME is very similar to an unbanked or underbanked individual. Most MSMEs started as “mom-and-pop stores” with highly informal documentation and financial record keeping. It would be quite costly for banks to provide financial services to this segment if they were to follow the traditional relationship-management model that they employ for large corporations.
At the same time, lenders cannot approach this on a portfolio basis – as they would under the consumer mortgage or credit card models – since there is not any official, certified financial data to perform analytics on. We find the most effective way to mitigate this is to digitise MSME information by onboarding them through an online platform while also applying data analytics for focused targeting and alternative credit scoring.
UNG: The most cost-effective way to decrease KYC costs and offer financial products and services to more MSMEs is by involving the government, not only as payer but also as a payee. Data analytics can then be deployed to target relevant financial products to specific segments of MSMEs.
AHMED: The government is already looking to harmonise its KYC regulations to enable greater access to financial services by targeting a larger segment of Filipinos and small enterprises. For example, the potential implementation of a national ID system and banking ID as proposed by the Bankers Association of the Philippines, on a combined basis, will better address the KYC issue by streamlining the authentication and verification process.
To what extent is blockchain technology gaining traction in the sector, and how would you assess its potential for improving financial inclusion?
UNG: Blockchain is still very much a nascent technology within the Philippine banking industry. One of the universal banks recently launched a blockchain-based project to link it to rural banks, thereby granting them access to the primary retail banking networks for ATM transactions as well as cheque clearing. This is the most promising initiative to date, although it does have some potential implications.
For the most part, the total direct and indirect fees associated with blockchain-based payment systems are greater than those associated with the existing, centralised retail payment systems. Furthermore, one of the most attractive characteristics of blockchain technology is its immutability; however, that could come under threat with the accelerated development of quantum computers.
BORROMEO: There are new structures emerging in the banking industry, even in how we deploy ATMs. There’s a group from Japan whose main business is operating ATMs, which could help banks outsource that part of their operations. Banks with fewer branches outside of the main urban centres can then leapfrog to the same level as the other banks that have a presence in all the provinces. If we can have shared services, like ATMs, it will significantly improve our ability to reach out to the unbanked.
I think Philippine banks are very open to new technologies, and if the risk associated with blockchain is proven to be manageable, then we will use the technology. We did the same with the ATM when it was first introduced in the 1980s, and with cheque processing and EMV technology, the chip-based system developed by Europay, Mastercard and Visa. This open-minded attitude to new technological advances is very important as it allows us to better service our customers and expand our reach.
BAUTISTA: What we are seeing with blockchain today can be compared to the early days of the internet. I recall that when the internet started, there were doubts about its potential. However, mass adoption happened very quickly, as real-life applications started to materialise. We tend to think of the same trend in terms of market acceptance in the case of blockchain technology.
Blockchain is already present in varying degrees. Not only does it exist in banking, but in a variety of other industries, with examples to be found in remittances, logistics, energy, e-commerce, transport and many other sectors. In a blockchain environment, intermediaries are removed from the equation, which makes it even more vital for to become aware of its applications. Its “smart contract” and peer-to-peer capability makes it an ideal tool for expanding financial inclusion.
How could Islamic banking and its approach to collateral requirements create alternative opportunities for the unbanked?
BORROMEO: I believe there is big potential for Islamic banking in the Philippines, particularly in Mindanao, which is home to a large Muslim population. Many Filipinos living there would be interested in sharia-compliant financial services.
However, the biggest stumbling block is that we have yet to formulate the policy and legislative framework for Islamic banking. We would like to see the proposed bills pending in Congress be taken up and discussed, and finally passed into law.
Since 2017 we have seen a lot of interest from Middle Eastern and Malaysian partners weighing up the possibility of entering this segment. One of the largest banks in Malaysia is very interested in the potential of Islamic banking in the Philippines, but they are still waiting for the framework to be established before making a decision. Moreover, the central bank will also require its own set of rules on how to regulate the Islamic banking segment.
Besides generating interest among unbanked Filipino Muslims, foreign investment from Muslim-majority countries could also widen the sources of financing for development projects in Mindanao and other parts of the country. The more financing alternatives we have, the better terms we can negotiate, which should accelerate infrastructure development and create opportunities for groups that are often excluded from the formal economy.
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