Digital Financial Services (or DFS for short) are a fundamental building block in every digital economy paradigm. Typically, DFS sits atop two other layers: a national digital ID system and a robust network of the underlying infrastructure. Once all three layers are accessible, innovation happens at-scale and the digital economy grows. The trajectory of DFS in Nepal exhibits parallels to other ecosystems but is also unique in certain respects. This writing attempts to unpack the more native elements and imagine the future course of DFS in Nepal.
Although DFS has come a long way over the past 5 years, Nepali banks and financial institutions (BFIs) have at best remained helpless spectators or at worst, willfully ignorant of the tectonic shifts that are reshaping and disintermediating the global banking industry. Extreme fragmentation within the banking sector has facilitated the entry and sustenance of third-party digital payment service providers and operators. These entrants have relentlessly consolidated market share around core electronic payments, settlements, and peripheral services while also cementing captive relationships with BFIs through white label product offerings.
Extreme fragmentation within the banking sector has facilitated the entry and sustenance of third-party digital payment service providers and operators.
To put matters in perspective, there are 27 “Class A” banks in Nepal, serving a population of approximately 30 million. This number, added to all other BFI classifications amounts to a stupendous ratio of financial institutions per capita in a country where about 30 percent of adults remain financially excluded. This situation is unsustainable and will result in a wave of balance sheet consolidations, accelerated by the COVID-19 onslaught.
Whether larger balance sheets will embolden Nepali BFIs with the strategic foresight to embark on their own DFS endeavors remains to be seen. Judging by the experience of those that have delved into this space, the nightmare of never-ending cash burn, a CAPEX-heavy enterprise, and costly lessons on “brand independence” and “interconnectivity” will be fresh. Not to forget, bottomless investments in DFS endeavors translate directly to foregone dividends for shareholders, many of whom view the “long term” in 12 months increments. These realities tilt the future of DFS in Nepal, decidedly in favor of third-party players.
In terms of appetite to digitize, there is some variance among BFIs but once again, balance sheet size is a deterministic factor. On this front, decision-makers have to confront the question of whether to sink capital now in anticipation of the emergence of a digitally-aware consumer class tomorrow or wait for the ecosystem to mature and then invest in appropriate tools and resources. Here, the least expensive proposition for incumbent BFIs is to continue leveraging white label products and services till such a time – if ever – when a capital investment in proprietary digital infrastructure is acceptable in traditional cost-benefit terms. And herein lies the rub – digital disruption is an exponential process whereas traditional BFIs are handicapped by linear thinking. This logic, fundamentally, is why the odds of a BFI-led DFS revolution in Nepal is more unlikely with each passing day.
Digital disruption is an exponential process whereas traditional BFIs are handicapped by linear thinking. This logic, fundamentally, is why the odds of a BFI-led DFS revolution in Nepal is more unlikely with each passing day.
This raises a logical question: what about the current state of play among Nepali BFIs in terms of their digital journeys? Awareness on this agenda among the leadership tier is adequate with some who are more passionate about innovation than others. BFIs that were relatively early in building out their remittance infrastructure are naturally ahead of the game; others speak of shelved efforts going as far back as a decade and amounting to millions of Rupees in sunk costs and write-offs.
However, digital awareness at the operating level is limited to promoting white-label mobile and internet banking offers and third-party wallets. At this level, digitization is equated with going paperless, and the relative immaturity of the ecosystem (including the regulatory regime and digital adoption), is cited as reasons why the process has been slow. These observations paint an explosive dichotomy within BFIs: of a leadership layer that is handicapped by the annual dividend cycle and broader market dynamics, and operational staff whose day-to-day experience suggests that innovation can be timed. Both perspectives will ensure a second-place for BFIs in the race for a Digital Nepal.
Finally, the role that the regulator (Nepal Rastra Bank or NRB) intends to play in helping promote DFS in Nepal, matters. Judging by recent actions halting new licenses and enforcing parity for all players that ride third-party networks, the signs are encouraging. NRB has also taken a number of measured steps that balance the need for private-sector-led growth with what’s in the public interest.
Nepal’s Central Bank also reversed its well-intended but ultimately, misguided limits regime on electronic transfers, and in doing so, put on display its propensity to listen and respond to stakeholders. The multi-million dollar question now, quite literally, is whether NRB will continue supporting third-party-led DFS growth, gradually switch to a BFI-led approach, or move to a model that mimics NPCI (National Payments Corporation of India)? The answer to this question rests as much on the lobbying power of groups like Nepal Bankers Association (after the on-going wave of balance sheet consolidations) as it does on the staying power of newly established DFS providers, and special considerations in the public interest in a post-COVID-19 world.
In summary, the BFI industry in Nepal is undergoing a disruption that is being fueled by rapidly changing consumer tastes, preferences, and now COVID-19. The chief architects of this revolution are third-party vendors who bet early on a “less-cash” Nepali future and the primary beneficiaries are ordinary consumers, who welcome the elimination of never-ending banking fees and added transactional convenience. All else being equal, the “insurgents” in Nepal’s DFS revolution are here to stay and it is these entrepreneurs who are best positioned to continue innovating Nepal into the global digital arena. The train, so to speak, has left the station and there is not much left for our BFIs to do but jump on board and enjoy the ride.