Standard Bank may be the biggest lender in Africa, but it still faces challenges from up-and-coming fintechs. (Photo by Dean Hutton/Bloomberg via Getty Images)

Africa’s fast-growing but under-banked population has financial services companies eyeing big opportunities on the continent.

In 2020, the region had a population of 1.34 billion people, which is forecast to jump to 1.87 billion by 2035 and 2.48 billion by 2050, according to Statista. Africa’s population is the fastest growing in the world on a continental level and it will account for almost half of global population growth over the next two decades. By the year 2050, the UN estimates that Africa will have 945 million people under the age of 25. It will be the biggest pool of tech-savvy young people on the globe, making up almost twice the young population of South Asia and South East Asia, East Asia and the Pacific region combined, according to the Bill & Melinda Gates Foundation.

African opportunities for banking the unbanked

Only 43% of Africa’s population has a traditional bank account, creating huge opportunities for financial services providers that are able to tap this massive unbanked market. Providers are trying to gain access to the masses through mobile feature phones and increasingly through smartphones. African mobile phone penetration is high and sub-Saharan Africa (SSA) is the world’s fastest-growing mobile phone market. It is already the world’s biggest mobile money market.

By the end of 2019, the SSA region had 477 million unique mobile subscribers, a number that is expected to jump to 614 million by 2025, according to GSMA Intelligence. The penetration rate will rise from 45% to 50% of the population during the period. Mobile operators in the region are expected to invest $52bn in infrastructure roll-outs between 2019 and 2025. The total number of SIM connections is forecast to reach one billion by 2025. Over the next five years, the number of smartphone connections in SSA will almost double to surpass 678 million by the end of 2025 – an adoption rate of 65%. Mobile internet users are expected to rise from 272 million in 2019 to 475 million in 2025.

In 2020, the number of registered mobile money accounts in the SSA region reached 548 million – up 12% on the previous year – representing almost half of the 1.2 billion accounts worldwide, according to GSMA Intelligence. Also in 2020, the total number of separate mobile money transactions in SSA amounted to 27.4 billion – up almost 15% on the previous year – with a total value of $490bn, up 23% on 2019. South Asia was the world’s second-biggest regional mobile money market with 7.5 billion separate transactions valued at $131bn.

The mobile money revolution is disrupting established banking in Africa, which traditionally has been one of the most profitable banking markets in the world. Fintech and paytech start-ups have been spawned in a number of countries – including Kenya, South Africa, Nigeria and Egypt – and are among the first unicorns produced in the region. The Covid-19 pandemic has led to a lot more e-commerce and accelerated the digitalisation of African banking and financial services.

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SSA is also the most expensive region in the world to send remittances to. The high costs and charges around financial services in Africa indicate that the region is ripe for more competition from fintech companies and neobanks.

How free-trade areas could benefit traditional banks

The African Continental Free Trade Area (AfCFTA) creates huge opportunities for established African banks to expand into other parts of the continent and for disruptive fintech start-ups to offer cross-country or pan-African financial services and payment solutions. AfCFTA is the world's largest free-trade area measured by the number of countries participating (54), and went live on 1 January 2021.

The next big leap in banking and financial services in the region is the introduction of blockchain technology that can exponentially accelerate trade on the continent, including cross-border trading. Samira Mensah, S&P Global Ratings

Incumbent banks have started to feel under threat by the disruption and are attempting to innovate rapidly or acquire fintech companies. Challenger banks or neobanks, they fear, are better placed to help countries' underserved communities achieve financial inclusion. Neobanks are fintech firms that offer apps, software and other technologies to streamline mobile and online banking. These fintechs generally specialise in particular financial products, such as savings accounts. Neobanking is popular in Africa, as it offers customers an array of services and features that were previously inaccessible, such as sending money to family and digital lending.

"Established banks in Africa have become tech companies with a banking licence," says Samira Mensah, director financial ratings services at S&P Global Ratings. "Banks in Nigeria, Kenya and South Africa are among the leaders in banking innovation in Africa. A lot of infrastructure gaps exist in the region – many people have a mobile phone but they do not have a smartphone. USSD technology has enabled person-to-person and person-to-business financial transactions to take off. Agency banking is also enabling financial services companies to reach unbanked populations in rural areas."

Unstructured Supplementary Service Data or USSD is a global system for mobile communications protocol that is used to send text messages. USSD applications run on the network, not on a user's device. In this way, they do not have to be installed on the user's phone, which is an advantage for users with feature phones that have limited storage space. Agency banking is a type of branchless banking that allows the traditional banks to extend their network of branches and services in a cost-efficient manner through authorised agents, and it is becoming more and more common throughout Africa. In Nigeria, for instance, the number of banking agents jumped by 517% to 237,000 in December 2019 from 38,400 in December 2018, according to the Central Bank of Nigeria.

"The next big leap in banking and financial services in the region is the introduction of blockchain technology that can exponentially accelerate trade on the continent, including cross-border trading," adds Mensah. "It could be a real catalyst to AfCFTA's implementation, for example, and is vital for the transformation of pan-African banking systems. Currently, cross-border transactions in Africa are using the Swift system, which usually takes three to five days to settle and is costly. Blockchain technology introduces transaction finality in a matter of minutes for a reduced cost. It has the potential to be an enabler of cross-border trade and remittances as long as there is interoperability between the commercial and central banks’ blockchain platforms."

Blockchain technology has the potential to revolutionise banking and financial services throughout Africa. It will become a lot more common as more Africans switch from feature phones to smartphones, as internet connectivity improves, as internet data charges fall, and as regulators devise pan-African rules for banking and financial services.

The potential for profits in Africa's banking market

Africa is the world’s second most profitable banking market after Latin America, with an average return on equity (RoE) of 14.9% in 2020 (in Latin America's biggest economies – Mexico and Brazil – the RoE was about 18%). By comparison, the global average RoE was 9%. Europe’s top RoE among big banks was 10.2% for ING Group in 2019, with German banks scoring less than 1%. US banks had a RoE range of 5–10% for years after the introduction of Basel III capital requirements in 2009 and only recently broke towards 11.4%.

It is hard to define [Africa's] 'main markets'. There are traditionally large and stable markets, fast-growing markets with less-developed financial sectors and many markets in flux between these two groups. Elizabeth Rossiello, AZA Finance

However, African banks are small in a global context. For example, four banks in the Gulf Cooperation Council region – with a population of 55 million people – are bigger than any single bank in Africa – with a population of more than 1.3 billion people. Qatar National Bank is the largest bank in the Middle East; its total assets are 60% greater than the biggest African bank, South Africa’s Standard Bank Group.

"Africa is a gigantic and diverse continent of 55 countries," says Elizabeth Rossiello, chief executive officer and founder of AZA Finance, a fintech provider of treasury and foreign exchange services. "It is hard to define 'main markets'. There are traditionally large and stable markets, fast-growing markets with less-developed financial sectors and many markets in flux between these two groups. Banking across the African continent has been profitable, as lending rates are incredibly high and interest paid is incredibly low. With just these two general statements, many African banking groups have been very profitable for years in urban areas particularly, without offering competitive services. The lack of competition in many markets is glaring."

Many international banking groups pulled out of Africa following the international financial crisis. For example, in March 2016, UK-based Barclays announced the sale of most its African businesses (in 2017, it sold most of its controlling stake in Absa, South Africa’s third-largest lender, and Barclays Africa changed its name to Absa in July 2018). This has created an opportunity for pan-African banking groups to enter the scene.

Four different pan-African groupings are emerging. The first is the South African banks – led by Standard Bank, Absa and Nedbank – which in the past have developed pan-African networks to reflect that country’s historical influence over the rest of the continent. However, appetite for further international expansion now appears limited. The second grouping is the large Moroccan banks (Attijariwafa, BCP and Bank of Africa, previously BMCE), which have used their sizeable domestic operations as a launch pad for expansion into the continent, with a focus on francophone and Arab countries. However, this expansion has stretched their balance sheets and analysts now expect a shift in focus towards integration.

In contrast to these two groups, Nigerian banks are showing greater appetite for acquisitions, partly driven by sluggish growth in the domestic market. Access Bank, Guaranty Trust Bank (GTB) and United Bank for Africa are all spreading their wings beyond the country in attempt to build an Africa-wide bank network. For example, Access Bank wants to expand its operations from 12 to 20 African countries and has made recent acquisitions and capital injections in South Africa, Zambia, Mozambique and Kenya. GTB is also looking to make a possible acquisition in Kenya to improve its scale in East Africa.

The fourth group is Kenyan banks, which have also been keen to expand into neighbouring markets, partly owing to pricing regulations that have limited their profitability in their core domestic lending operations. Kenyan banks Equity Group, KCB Group and DTB Group have actively grown their regional reach.

Ecobank – a pan-African banking conglomerate headquartered in Lomé in Togo – has banking operations in 36 African countries. It is the leading independent regional banking group in western Africa and central Africa. It also maintains subsidiaries in eastern and southern Africa.

“Very big potential exists for African banks to profitably expand on the continent," says Constantinos Kypreos, senior vice-president at Moody's Investors Service. "The continent is under-banked and underserved. There is the potential for these banks to grow and be very profitable. Africa has the lowest financial inclusion in the world and – in conjunction with new technology – that creates many opportunities for financial services companies to expand and service the previously unbanked or under-banked businesses and individuals. However, risks are high – partly relating to rising government deficits and generally weak institutions – so good risk management and planning remains a prerequisite.”

Other African banking groups are expected to join the trend of improving their scale in other African countries to diversify risk and earnings. Pan-African banks have penetrated markets such as trade financing that were once exclusive to foreign lenders. They have opened foreign currency accounts and are able to meet clients’ import and export needs. Pan-African financial institutions such as Attijariwafa Bank and Afriland First Group have partnered with Chinese banks so that they do not have to depend on Western banks for their correspondent banking. Others have expanded outside Africa and started operations in places such as London, Dubai, Paris and Beijing. These overseas subsidiaries are able to act as a correspondent bank for other lenders in Africa.

Why Africa's banking landscape is consolidating

Africa is already experiencing huge consolidation among its established banks. The number of banks in Nigeria, for instance, has nosedived from 89 in 2004 to 27 in February last year. Between 2016 and February 2020, Kenya saw ten mergers and acquisitions and three bank failures. In many countries, banks with heavy fixed costs from 'bricks and mortar' branches have come under financial pressure.

Consolidation – particularly at the cross-border level ­– would help to create regional champions that would register at the international level. Rahul Shah, Tellimer

A number of other African banking groups are ripe for acquisition – particularly the lower-tier banks with weaker balance sheets, lower capital, and that are struggling to scale and compete – by larger and better-capitalised banks. However, the pace of consolidation will vary widely across countries. Nigeria and South Africa have more mature banking systems and are likely to see less consolidation than smaller markets.

"Consolidation – particularly at the cross-border level ­– would help to create regional champions that would register at the international level," says Rahul Shah, head of financials sector equity research at Tellimer, a London-based economic consultancy.

AZA Finance's Rossiello says: "Traditional African banking groups have been ripe for consolidation for years. Their lack of innovation, their lack of expansion across multiple markets, their high fees and their slowness all make them a target for disruption or buyouts. I have seen more of the former, as fintechs fill the gap in competitive product offering that these banking groups have left empty for years. The buyouts that have occurred have been more to close down inefficient banks or even exit markets.

"The key word here is pan-African. Entrepreneurs, businesses, multinational corporates are looking for banking partners that can work across the continent and do so in a low-cost, highly efficient way. Africans want mass payout APIs, they want web-based payment platforms, they want digital currency support – and they want it available across multiple markets and currencies."

APIs are software applications used to develop other apps that connect to other companies’ pre-existing technology. This interfacing enables a third-party application to access a bank’s common tools, services and valuable assets, including financial information, customer accounts and product catalogues. They make it quick, convenient and cost-effective for the bank and the third party to connect.

Currently, about two-thirds of African banks' operating revenues come from interest income and one-third comes from fees and commissions, but the mix is changing, according to S&P Global.

"Banks’ strategy is to rely less and less on interest income that forms the majority of their income and more on non-funded income, which relates to income associated with transactional banking, payment and transfers," says Mensah. "This enables banks to strengthen their earnings capacity during an economic downturn or market volatility."

How Kenya became a mobile banking pioneer

The worldwide mobile banking revolution started in Kenya. In 2007, Kenya’s Commercial Bank of Africa launched a partnership with Safaricom, the Kenyan mobile operator, which gave rise to the M-Pesa and M-Shwari mobile money banking products. M-Pesa now accounts for just over one-third of Safaricom’s service revenues, underlining the growth potential of digital financial services for mobile operators. According to the Central Bank of Kenya, by July 2021 the country had 68.5 million mobile money accounts and 303,000 mobile money agents. During 2019, there were 1.8 billion mobile money transactions totalling $42.9bn across all providers, some 45% of the country's GDP.

East Africa is the most mature mobile money market in Africa, accounting for more than half of the region's total registered accounts. During 2020, this subregion's registered accounts stood at 293 million, up 9% on 2019, according to GSMA Intelligence. The total value of mobile money transactions in East Africa reached $273bn, 11% up on 2019. West Africa was the second most significant subregion in 2020 with 198 million registered accounts and transactions valued at $178bn. Central Africa was in third place with 46 million accounts and transactions valued at $35.7bn, followed by North Africa with 14 million accounts and $5.4bn in transactions and southern Africa with 11 million accounts and $3bn in transactions.

Total remittances to SSA plummeted by an estimated 12.5% in 2020 to $42bn, according to the World Bank. The decline was almost entirely due to a 27.7% drop in remittance flows to Nigeria, which alone accounted for more than 40% of remittance flows to the region. The steep fall in Nigeria was attributed to the impact of the Covid-19 pandemic.

SSA is the most expensive region in the world to send a remittance to: in the fourth quarter of 2020, sending $200 to the SSA region cost on average 8.2%, compared with 6.5% globally, according to the World Bank. Within the region – which experiences high intra-regional migration – it is particularly expensive to send money from South Africa to Botswana (19.6%), Zimbabwe (14%) and Malawi (16%).

It is a lot cheaper to send money to SSA digitally than in cash: the total cost for a cash remittance was 8.94% in 2020 (made up of 6.19% in fees and 2.75% in the foreign exchange margin) while for a digital transfer it was 6.44% (made up of 4.24% in fees and 2.2% in the foreign exchange margin).

Innovative fintech companies are springing up throughout Africa, threatening established banking groups with greater competition. Fawry – Egypt’s top e-payment platform and leading fintech – became Africa’s first unicorn last year via a listing on an African bourse. Founded in 2008 by Ashraf Sabry and Mohamed Okasha, the company listed on the Egyptian Exchange, the country’s main bourse, in August 2020 and was valued at $275m. Two months later its valuation surpassed more than $1bn.

Fawry offers an online payment gateway for business owners to transact with customers via cash, credit cards and e-wallets. It has helped to transform the Egyptian economy by reducing the reliance on cash, lowering costs and offering a more convenient way to pay. It is only the third African start-up to reach unicorn status and the first one to do so through going public on an African stock exchange.

Jumia, a pan-African e-commerce company based in Lagos, was the first unicorn out of Africa after listing on the New York Stock Exchange in April 2019. In November 2019, Interswitch, the Nigerian digital payments company, also achieved unicorn status after Visa acquired a minority stake.

South Africa’s TymeBank – an exclusively digital cloud-based retail bank – announced in July 2020 that it had reached two million customers – including 18,000 small businesses. Only launched in February 2019, it said it was adding 6,000 customers each working day, including some 400,000 during lockdown, and had attracted R10bn ($613m) in deposits.

In July 2020, Vodacom joined forces with digital payment platform Alipay to create a ‘super app’ for South Africa that offers personalised financial, business and lifestyle services, including lending and insurance for small and medium-sized enterprises and bill payments and money transfers for consumers. In July 2020, Orange and financial services company NSIA Group partnered to launch Orange Bank Africa in Côte d’Ivoire, with plans to expand into Senegal, Mali and Burkina Faso. The bank will offer a range of savings and microcredit services via Orange Money.

Safaricom partnered with Visa in April 2020, connecting M-Pesa’s 24 million accounts and 173,000 local merchants to Visa’s global network (61 million merchants and three billion cards). In October 2019, Airtel Africa partnered with Mastercard, enabling Airtel Money customers to make payments to local and global online merchants. The partnership gives Airtel Africa’s subscriber base across 14 countries access to Mastercard’s global network.

A start-up to watch is MoneyFellows – a Cairo-based fintech that has digitalised the concept of a rotating savings and credit association – and that raised $4m in a Series A round in June 2020.

African banks and the race to embrace digitalisation

African banks now stand at a crossroads in relation to digitalisation – brought on by mounting competition from mobile operators and neobanks as well as the impact of the Covid-19 pandemic. Established banks are mainly using fintech solutions to optimise their liability management rather than any other purpose. However, enormous opportunities exist for fintech and blockchain technology to be used in many other areas of banking and financial services.

"In the era of digital disruption, sectors that are unable or unwilling to evolve place themselves in danger from the pressure of new, more client-focused services," said Matthijs Eijpe, regional vice president Europe, Middle East and Africa at Backbase, an Amsterdam-based provider of engagement banking platforms, in a recent article. "In Africa, where 57% of the population does not use traditional bank services, there is a huge opportunity for growth, particularly as more and more Africans are starting small businesses. The immense popularity of mobile money is proof of that."

African banks can adopt one of four distinct digital strategies, according to McKinsey. The first is to digitally transform their existing operations, to increase their share of digital sales and transactions to beyond 60–70% on each measure, as Kenya-based Equity Bank has done. Second, banks can partner with telecommunications companies or fintechs to deliver mobile financial services to their clients at a lower cost than the branch network. An example, also from Kenya, is M-Shwari, the mobile-based loans application formed in a partnership between Commercial Bank of Africa and Safaricom.

The third digital strategy is to build a digital bank from scratch, as Nigeria’s Wema Bank did in launching ALAT, Africa’s first fully digital bank, in 2017. Finally, banks can build an ecosystem or platform of non-banking services. Alipay in China and the Commercial Bank of Australia have applied this approach at scale in areas such as travel and hospitality (Alipay) and home-buying (CBA).

Digital payments and broader financial services also provide an opportunity for mobile operators in the region to diversify beyond connectivity. For many of them, mobile money provides a solid platform from which to leverage the opportunities in the digital payments ecosystem. Building on existing mobile money services and the rapid expansion of the fintech ecosystem, mobile operators are introducing innovative features and establishing new partnerships to service customers better; for example, in digital payments.

Asset tokenisation is also a way in which neobanks can enter the lending market. It can be a new avenue for previously unbanked economic operators to raise funding against real assets, which are generally not accepted as collateral in the traditional lending system. For instance, an unbanked small farmer in a village could tokenise its output and raise funding against it on an organised and secure peer-to-peer market as long as he or she has access to a smartphone and an internet connection.

However, established banks have a distinct advantage over challengers, as it is extremely hard for mobile operators or fintech companies to obtain banking licences in Africa and to enter the credit market, for example. They also enjoy a close relationship with the central banks, regulators and governments.

"Mobile money – while easy to use – is not a long-term solution for the unbanked," added Mr Eijpe. "Unlike traditional banking systems, mobile money does not enjoy the trust of regulators and has no systems in place to avoid fraud or money laundering. Research shows that unbanked customers who begin using mobile money will want more complex banking services later on, seeking stronger customer protection. Banks should use this to their advantage, offering traditional services such as savings accounts to mobile money clients, while offering the sort of convenience that those clients have become accustomed to."

AfCFTA could transform banking in the region

AfCFTA could be an economic game changer for Africa – if it is implemented effectively by the region's main economies. Founded in 2018, and with a secretariat based in Accra, Ghana's capital city, it started trading on 1 January 2021. By March, 36 countries had ratified it and undertaken the legal obligations for market opening and reducing barriers to trade. Only 18% of all Africa’s commerce at the moment is intra-African trade, while the equivalent figure in East Asia is about 35–40%. AfCFTA has the potential to double intra-African trade by 2035, according to its own estimates.

It is hard to separate the traditional banks from the government and regulatory bodies in much of the AfCFTA region. Elizabeth Rossiello

The Pan-African Payments and Settlement System is a centralised payment and settlement infrastructure for intra-African trade and commerce payments being developed by AfCFTA in collaboration with the African Export-Import Bank. It will facilitate payments as well as formalise some of the unrecorded trade, owing to the prevalence of informal cross-border commerce in the region.

"It will be impossible to realise a truly pan-African payment and settlement system without opening up this project to more competitive and innovative stakeholders," says AZA Finance's Rossiello. "It is hard to separate the traditional banks from the government and regulatory bodies in much of the AfCFTA region. There is a lot of cooperation with incumbents in the financial sector, sometimes to the detriment of the population. In that sense, if there is strong resistance from the traditional banks and their powerful lobby, the success of AfCFTA is at risk."

In September, the Switzerland-based Bank for International Settlements also said it is leading a project to test the use of central bank digital currencies for international settlements. The central banks of South Africa, Australia, Singapore and Malaysia are taking part.

Things do not always change fast in Africa and the region's established banks – sitting on hefty profits – have been slow to adopt new technologies. However, growing competition from neobanks and mobile operators, in combination with the pandemic, is accelerating the pace of change. AfCFTA has the potential to speed it up further. More and more Africans are becoming used to making digital payments. Blockchain solutions will take off in the region as Africans in massive numbers shift to smartphones. Established banks must start to move fast, otherwise disruptive fintechs and neobanks will seize the opportunities first.