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SEEDING INNOVATIONA framework for rooting FinTechs in Pakistan

UzmaToor

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Disclaimer

© Karandaaz Pakistan 2016

This report has been produced independently by FinSurgents on the request of Karandaaz Pakistan.

The information, statements, statistics and research (together with the ‘information’) contained in this

report have been prepared by FinSurgents from publicly available material and interviews with industry

experts. FinSurgents does not express an opinion as to the accuracy or completeness of the information

provided by the third parties, the assumptions made by the parties that provided the information or any

conclusions reached by those parties.

The views expressed in this document are those of the authors and do not necessarily reflect the views

and policies of Karandaaz Pakistan or the donors who have funded the study.

No part of this report may be reproduced, disclosed, or distributed by any process without the express

prior written consent of Karandaaz Pakistan. Requests and inquiries concerning reproduction and

rights should be addressed to Karandaaz at [email protected]

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Acknowledgements

We would like to recognize the contribution of a number of experts without whom this FinSurgents’

production would not have been possible. In particular, we would like to thank members of the

FinSurgents advisory board Nabeel Malik, Sandeep Dhar, Muqeet Salam and Yasir Ali for their

invaluable contributions through frequently challenging and refining our thinking. We also appreciate

the role Atiya Shah and Mughees Tanvir Butt played in the finalization of the report.

The team would also like to acknowledge the expert input received from a number of industry

practitioners and leaders. While creating the Investment Framework, FinSurgents appreciates the

contributions of Sherazam Mazari (Sabre Group) and Tahira Dosani (ACCION) who provided insights

that were used in the body of work. We also acknowledge the contribution of William Cook whose

feedback helped in refining this report.

We would like to thank Aamir Attaa for extending the Pro-Pakistani platform for carrying out the

FinTech Pakistan 2015 survey.

We would also like to thank Obaid Saleem (GSMA Pakistan) and Muneeb Myers (Ex-CEO Daraaz.pk) for

their help.

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List of Industry Practitioners and Subject Matter Experts

We are thankful to the following industry practitioners and subject matter experts who shared their valuable perspectives for this study.

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Abdul Wajid

Adam Dawood

Adnan Faisal

Ali M Kazmi

Ali Sikander

Amir Masood

Ammar Naveed Ikhlas

Ashfaque Ahmed

Asma Ahmed

Ayesha Baig

Azfar Jamal

Baqar Jafri

Faeyza Khan

Fahad Shahab

Faisal Ijaz Khan

Faisal Khan

Trade/Credits Officer

Co-Founder and MD

Director

Chairman

Senior Management

CEO

Head of Branchless Banking

Head of Technology

Senior Executive

Head, Product Management and

Research

EVP / Head - Payment Services &

E-Banking

CEO

Investment Officer

Head Business Development

CEO

CEO

Bank AlHabib Ltd

Kaymu

NUST TIC

Knightsbridge Capital

Group

Monet Pvt Ltd.

First Microfinance

Bank

Bank Alfalah

EFU Life

EFMA

First MicroFinance

Bank Ltd.

National Bank

Investors Lounge

(Finox Pvt Ltd.)

IFC - World Bank

NIFT

1-Link

Faisal Khan and Co.

Faizan

Farhat Karim Hashmi

Fred de Beer

Hafsa Shorish

Haider Wahab

Haris Multani

Haris Naseer

Haseeb Kasbati

Jamshaid

Khan Kashif Khan

Khurram Shaikh

Lara Gidvani

M. Abrar Ameen

Monis Rahman

Muhammad Ali Mirza

Muhammad Nauman Aman

Muhammad Sajid Farooqi

Muhammad Yar Hiraj

Mujeeb Ahmed Saeed

Marketing

Director Research

CEO

Program Manager

CEO

Director

Director - Marketing and Alliances

CFO

GM

COO

EVP - Head Branchless Banking and

Digital Banking

Regulatory Specialist - ASIA

CEO

CEO

Assistant Brand Manager

Senior IT Assistant

CEO

CEO

CIO

Bookme.pk

ZTBL

Adamjee Life

Plan X

NIFT

Crest Technologies

InfoTech Group

IGI Insurance

IGI Insurance

Al Shaheer

Meezan Bank

GSMA

VRG Pvt Ltd.

Rozee.pk

Dalda Foods Pvt Ltd.

ICMAP

Global Financial

Systems

OneLoad

Askari Bank

List of Industry Practitioners and Subject Matter Experts

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Nadeem Hussain

Noman Azhar

Nuvin

Obaid Saleem

Omer Moeen

Owais Zaidi

Rashid Khan

Raza Hasan

Sadia Khan

Shahid Bhutto

Shahzad Shahid

Shakir Hussain

Sidra

Syed Ammar Haider

Tariq Mian

Umer Fareed

Umer Munawar

Usman Javaid

Yousaf Ghous

Yousaf Nasir

Yousif Rauf Javed

Founder

Head of Mobile Financial Services and

Mobile Governance

IT Head

Service Provider Engagement Lead

Director Strategy

Founder and CEO

Managing Partner

AGM

COO

Director

CEO

CEO

Co-Founder

Head of Sales - Branchless

CEO

Group Head Marketing, Corporate

Affairs & Alternate Delivery Channels

COO

Director

CEO

CIO

Software Quality Assurance Engineer

Planet N Group of

Companies

Ufone

FINCA Microfinance

Bank

GSMA

Telenor Easypiasa

Credit Fix

Fishbowl Pvt Ltd.

EFU Life

Autosoft Dynamics

Zong

TPS

Creative Chaos

Markhor

Bank Alfalah

Image Graphic

Solutions

Burj Bank

FINJA

NADRA

Gemalto

SBP/HBFCL

DealSmash

Authors

v

Qasif ShahidFounder & [email protected]

Ahsan [email protected]

Lubna Razaq [email protected]

Myra [email protected]

Mahrukh ImtiazResearch Analyst

Omar ShahidDigital Marketing Manager

QS

AM

LR

MP

MP

OS

About Karandaaz

Karandaaz Pakistan (www.karandaaz.com.pk), a Section 42 company established in August 2014,

promotes access to finance for small businesses through a commercially directed investment platform,

and financial inclusion for individuals by employing technology enabled digital solutions. The Company

has financial and institutional support from leading international development finance institutions;

principally United Kingdom Department for International Development (DFID) and the Bill & Melinda

Gates Foundation. The Consultative Group to Assist the Poor (CGAP), a member of the World Bank

Group, managed the start-up phase of the Company and continues to provide technical support.

The Company has three work streams, Digital Financial Services, Corporate Investment and Credit and

Knowledge Management and Communications. Karandaaz Pakistan is sponsored and governed by

eminent Pakistanis, and is managed by an experienced team with core expertise in international

investment management and digital finance.

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About FinSurgents

FinSurgents is a FinTech consulting practice with a core team comprising strategy, design and

technology experts. It operates at the confluence of business strategy and emerging technologies and

specializes in harnessing these forces to make revolutionary strides in existing business and operating

models.

The company’s principal expertise lies in fields of Analog to Digital transformation, Digital/Mobile

Payments, Business Process Re-Engineering, Digital Banking, and Product Management. For

additional information, visit www.finsurgents.com or email us at [email protected].

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Executive Summary

Financial services are crucial, not only for the economic and social development of a country but also for the reduction of poverty. With 85% of the population lacking access to formal financial services, financial inclusion is a dominant problem in Pakistan. The high cost of banking infrastructure prevents the dissemination of financial services beyond a small portion of the population. However, Digital Financial Services offer a promising potential to overcome problems of reach and scale. FinTechs not only offer the means for digitization but also have a significant role to play in emerging markets with low financial inclusion as agreed by 92% of senior executives and 80% of middle managers in the FinTech Survey 2016. FinTechs can be defined as: “small companies and startups obsessed with redefining the financial services value chain through digitization.” Inevitably, FinTechs are expected to play a major role in displacing cash, digitizing payments and documenting the economy. This study commissioned by Karandaaz Pakistan devises a framework for FinTech ecosystem development and prepares a roadmap for investment into FinTech verticals or segments (e.g.

payments, lending, insurance, etc.) in Pakistan.

In-depth analysis of the current state of the FinTech ecosystem, financial services in Pakistan, potential areas of investment, and recommendations for the growth of the FinTech ecosystem in Pakistan together with reducing the risks associated with investments in FinTech startups, all come within the ambit of this study. A comprehensive paper has thus been prepared, based on primary market research involving face-to-face interviews with 57 senior executives and 3,000 surveys with professionals from FinTechs, commercial and microfinance banks, insurance, startups, incubators, mobile financial services providers, and technology and telecom companies. The research conducted has provided insight into the challenges faced by the participants of the local FinTech ecosystem in harnessing the power of FinTechs.

The secondary research concentrates on global precedence regarding the dynamics of interplay between the components of mature FinTech

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Executive Summary

ix

ecosystems, and a review of the demographics and the financial services in Pakistan. The application of our knowledge base and expertise to the research, helps us forecast the growth model for a FinTech ecosystem in Pakistan, together with a framework for investment into the FinTech opportunity verticals.

Below is a brief overview of the study for easy reference:

Global Trends on Regulatory and Policy Support for FinTechs

• Globally, two types of regulatory mindsets are observed with respect to FinTechs. The one prevalent in mature hubs allows financial institutions to venture into spaces unless explicitly restricted for example regulators like FCA-UK, MAS Singapore, and ASIC Australia, while the other allows activity in areas specifically approved by the regulator which leaves little room for maneuvering. Regulatory approach promoting FinTechs entails working to establish the right balance between control and experimentation for FinTechs to innovate and scale through the creation of Innovation Schemes which identify the potential areas of focus, layout funds for supporting them and

dedicated FinTech wings within a regulatory body for close observation, consultation, regulation and authorization of FinTech verticals and companies.

• Employing methods of interacting with the industry, regulators gather feedback on whether regulations

are hindering innovation or nurturing it. • They adopt a Sandbox environment to test products

by limiting exposure and hence reduce risks associated with exposure. It allows FinTechs to make their platform available to a limited number of consumers and test their ideas within predefined parameters.

• There is a focus towards promoting the use of technology to simplify compliance, commonly known as RegTech.

• FinTechs are promoted through policy and regulation. The UK government announced tax efficiencies for P2P lenders and introduced requirements for mainstream banks to refer small businesses to alternative finance providers if they are unable to lend to them.

Current Regulatory Environment in Pakistan31% of the respondents of the Pakistan FinTech survey think that regulatory uncertainty exists around financial technology products and services

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in Pakistan. • The payment vertical has the most evolved set of

regulations with the Payment Service Operator or Payment Service Provider licenses, but the high capital requirement of USD 200 million is a barrier to entry for small FinTechs.

• Financial inclusion is a key focus of the State Bank of Pakistan which has issued the Branchless Banking Regulation for launching mobile wallet services and Asaan Account regulation which allows banks to open lower value accounts with minimum due diligence.

Creating a FinTech Friendly Regulatory Environment The necessary infrastructure for DFS has been created in Pakistan owing to the progressive regulations like branchless banking and verified SIMs. The creation of FinTechs is the natural next step. To create a FinTech conducive ecosystem, regulators in Pakistan can create a balance between oversight on FinTechs with the flexibility to innovate. This can be done by creating dedicated FinTech wings with mechanisms such as FinTech consultation departments and regulatory sandboxes to reduce the cost and time of compliance for FinTechs. At the same time, the

regulators also need to engage with industry participants, both incumbents and FinTechs, to create FinTech friendly regulations.

• The prevalent compliance scenario in Pakistan and the nascent FinTech ecosystem suggests that FinTechs working on top of incumbent financial

institutions acting as platforms are more likely to yield the best results at this stage.

• Large and small commercial and microfinance banks, insurance providers, and PSO and PSP license holders can all act as platforms for FinTechs to take away the regulatory burden from FinTechs while providing them with a mature compliance environment and reduce the oversight burden on the regulator as well.

• The State Bank of Pakistan should provide clear directives for FinTechs working with banks and those working independently.

• SBP can form a dedicated FinTech wing in collaboration with other regulators (NADRA, PTA, SECP) to educate, observe and guide FinTechs, create FinTech regulations and participate in developing a regulatory sandbox.

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FinTech Opportunity and Financial InstitutionsBanks face many hurdles in realizing FinTech potential, including lack of relevant human resources to capitalize on technology related opportunities, an organizational structure with product silos and a narrow focus towards functional KPIs limiting sight of future opportunities.

• On the FinTech side, most commonly cite challenges include an unfavorable attitude of incumbents for partnerships, a challenging regulatory environment, difficulty in modifying consumer behavior and lack of early stage funding.

• Financial institutions must understand the collaborative potential of FinTechs and develop the capacity to work with them. Globally, financial institutions are beginning to understand the potential for collaboration with FinTechs to meet customer demands in an increasingly digital and regulated landscape. FinTechs in return can provide financial institutions with differentiated and value-added products. For innovation to take place, the process has to be de-hinged from banks which are limited by their organizational design of product silos and legacy thinking. Banks need to tap into the inner circle of their customer base and truly engage them by

building products on the Social, Mobile, Analytic and Cloud model- the SMAC Stack. The same applies to other incumbents. Consequently, the recommended course of action for financial institutions is to take the position of platforms which collaborate with FinTechs by opening up APIs and providing regulatory compliance.

State of the FinTech Ecosystem in Pakistan• A FinTech ecosystem consists of regulators,

financial institutions, startup environment, FinTech startups and supporting entities such as infrastructure and identity providers, government funding and policy support.

• Mature hubs are characterized by FinTech friendly regulations and policies, dedicated incubators and accelerators and related activity beyond the prominent verticals of payments and lending. Besides, a high VC deal volume across the sector and active participation by the incumbents is mandatory. Pakistan possesses a nascent FinTech ecosystem characterized by gaps in multiple information areas hampering all ecosystem participants and hierarchies, a nascent startup environment with few FinTechs, investment generated only from local

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Executive Summary

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investors, and a lack of collaboration platforms for FinTechs, investors, and incumbents. At present, the most fundamental information gap is a lack of understanding regarding FinTechs and the value they offer for emerging markets. The first step is the creation of awareness about FinTechs achieved through workshops, conferences, seminars and the creation and publication of

educational content for disseminating information to FinTechs.

• For FinTechs to originate and flourish, the FinTech ecosystem in Pakistan needs to progress from a nascent to a mature state.

Developing the FinTech Ecosystem in Pakistan • To minimize the risk in FinTech investments, the

nascent FinTech ecosystem must be developed to ensure support for FinTechs throughout their lifecycle i.e. inception, initiation, commercialization, and exit.

• This support can be extended through the creation of a ‘FinTech Connector’ encompassing idea generation, selection and incubation setup, test environment (sandbox) and investment. These are further supplemented by functions of FinTech education, collaboration, and advisory. The

FinTech ecosystem growth model must be designed to capitalize on the growth of incubators, investors, and FinTechs in Pakistan.

Investment in FinTechs • Karandaaz is recommended to create a separate

legal entity within its structure for FinTech investment purposes to isolate the risk of investments from the parent company. This special entity will manage two different funds for investing into FinTechs;

a) Seed-Stage Fund for FinTechs with Karandaaz as the only investor at the inception and initiation stages

b) Growth Stage Fund which is open to all investors, including Karandaaz, for the commercialization stage and beyond.

• The FinTech verticals for investment are initially selected from the list given at the end. Our measured analysis recommends that Digital Credit FinTechs are worthy of special focus owing to a credit hungry local market and the ability of digital credit to be the use case which encourages adoption of Digital Financial Services in Pakistan.FinTech solutions worthy of investment, fulfill the criteria of businesses of the future. They work as

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platforms and create valuable interactions between sellers, consumers, and buyers. These can either be the tools required to run a FinTech business or the customer facing FinTech businesses themselves.

• Overall, a culture of innovation and experimentation in the field of financial technology must be promoted. Interest in FinTech entrepreneurship and intrapreneurship has to be garnered through the promotion of FinTech propositions and the opportunity to create FinTech solutions for the local market.

• Faith in local talent has to be demonstrated by providing an incubation setup, funding, and advice to local FinTech startups.

• Lastly, sustainability must be ensured by developing comprehensive programs that attract multiple contributors along with Karandaaz to participate in the overall growth of FinTech ecosystem and FinTech startups in Pakistan.

Verticals for Investment

No Regulation Required RegTech solutions

Non-investment crowdfunding (pre-orders, rewards, discounts, etc.)

Digitizing business processes

Supply Chain Digitization

Mobility Solution

Data Analytics

Customer experience solutions (predictive analytics)

Insurance marketplace / platforms

Loyalty and Discounts, closed loop wallets

Financial Solution Suite for SMEs (tax, payroll, invoicing, accounting)

Wealth Management Marketplace

•••••••••••

No specific regulation

exists in Pakistan but

generally required

P2P lending platforms/ marketplaces

Agri lending platforms/ marketplaces

SME lending platforms/ marketplaces

Wealth Management Algorithm

Crowdfunding (equity, real estate, etc.)

•••••

Regulation exists,

requires partnership

with incumbent

Digital Credit

Credit Scoring (individuals, SMEs, Agri)

Use cases for Mobile Wallets

Digital retail payments

Escrow as a service

Virtual cards

International Remittance Startups

Formalizing/digitizing the Rotating Savings and Credit Associations

(ROSCA)

••••••••

AML

API

ASIC

BAU

BISP

CAPEX

CFO

CGAP

CIO

CNIC

COD

CPEC

DFS

FCA UK

FOREX

G2P

GDP

GSM

IBFT

ICT

IPO

IRR

JOBS ACT

JV

Anti-Money Laundering

Application Programming Interface

Australian Securities and Investments Commission

Business as Usual

Benazir Income Support Program

Capital Expenditure

Chief Financial Officer

Consultative Group to Assist the Poor

Chief Investment Officer

Computerized National Identity Card

Cash on Delivery

China-Pakistan Economic Corridor

Digital Financial Services

Financial Conduct Authority, United Kingdom

Foreign Exchange

Government to Person

Gross Domestic Product

Global System for Mobile Communications

Inter Bank Fund Transfers

Information and Communication Technology

Initial Public Offering

Internal Rate of Return

Jumpstart Our Business Startups Act

Joint Venture

ABBREVIATIONS

KPI

KYC

M&A

MAS

MDR

MFS

MoU

mPOS

MVP

NADRA

OTC

OTT

P2P

POS

PSO

PSP

PTA

ROFR

SECP

SME

SMS

SPV/SPE

USSD

VC

Key Performance Indicators

Know Your Customer

Mergers and Acquisition

Monetary Authority Singapore

Monthly Discount Rate

Mobile Financial Services

Memorandum of Understanding

Mobile Point of Sale

Minimum Viable Product

National Database and Registration Authority

Over the Counter

Over the Top

Peer to Peer

Point of Sale

Payment System Operators

Payment Service Providers

Pakistan Telecommunication Authority

Right of First Refusal

Securities and Exchange Commission of Pakistan

Small Medium Enterprise

Short Message Service

Special Purpose Vehicle/Special Purpose Entity

Unstructured Supplementary Service Data

Venture Capitalist

ABBREVIATIONS

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1 INTRODUCTION TO FINTECHS: CONTEXT & BACKGROUND

Image Source: shutterstock.com

1 INTRODUCTION TO FINTECHS: CONTEXT & BACKGROUND

We are entering an age where the sociological, financial and technological changes over the last decade

have led to the creation of Emergent FinTechs. Emergent FinTechs will not only unleash innovations

resulting in a series of large-scale behavioral changes but also re-invent the relationship individuals have

with their money. It seems that this change will be most pronounced in emerging markets.

INTRODUCTION TO FINTECHS: CONTEXT & BACKGROUND 1

03SEEDING INNOVATION: A framework for rooting FinTechs in Pakistan

Introduction to FinTechs: Context and Background

Large-scale behavioral changes occur when technology and business model innovations fulfill unmet societal needs. Emerging markets have a greater room for disruption because basic human needs like water, health, education, financial services and employment, etc. are not entirely met. Therefore, innovative technology and business process re-engineering have an opportunity to create solutions, fulfill gaps and succeed. These innovations have a high likelihood of success in multiple industries, including the financial sector, due to cash based economies and unbanked masses (the terminology of unbanked wherever used in this report represents both the under-banked and unbanked segments of the population). The confluence of several enablers, such as increasing internet/smartphone penetration and the snowballing usage of mobile technology for performing everyday functions is expected to digitize the financial services value chain which will cater to the unbanked population which has long been neglected by the financial institutions. Additionally, Pakistan as a market exhibits potential for the digitization of payments and the economy.

1.1 The Purpose of the Study and Methodology

The overall purpose of this study is to suggest a roadmap for FinTech ecosystem development in Pakistan and a framework for Karandaaz to invest in local FinTech startups.

The study provides an overview of the existing digital financial services landscape in Pakistan. It analyzes and identifies the existing gaps, points out opportunities for FinTechs and predicts the future of Digital Financial Services (DFS).

Based on the identification and analysis of the developed FinTech hubs around the world and their components, this study outlines a model of growth for the FinTech ecosystem in Pakistan. An overview of the salient aspects of the regulatory environment in Pakistan is provided, leading to suggestions on the role of regulators in promoting FinTechs in Pakistan. After analyzing the startup ecosystem, gaps are identified to make recommendations for creating necessary support for FinTechs.

The investment framework identifies FinTech verticals for investment by Karandaaz and the preferred characteristics of a FinTech business. It also devises a mechanism for Karandaaz to invest in FinTechs while identifying the risks and suggesting mitigation strategies to minimize these risks.

The chapter-wise goals of this study are the following:

Chapter 1

Provide a context of the Pakistani market in which the study is conducted. Describe the changes in technology adoption, paving the way for FinTechs, its history, and its definition.Predict the future of Digital Financial Services in Pakistan and the way forward for FinTechs.

Chapter 2

Overview of the demographic, economic, technology infrastructure and consumer behavior factors aiding and hindering the FinTech opportunity in Pakistan. Overview of the existing financial services landscape to spot opportunities for Digital Financial Services created by FinTechs. Redefine the lens through which FinTech opportunities in Pakistan are assessed.

Chapter 3

Review FinTech hubs around the world to explore the stages of ecosystem growth and the components of a developed FinTech ecosystem. Review the trends across the globe for regulatory best practices for FinTechs.Give an overview of the salient aspects of the regulatory environment in Pakistan relevant to FinTechs and the suggested role of regulators in promoting FinTechs in Pakistan.

Identify the challenges and opportunities for incumbents with respect to FinTechs and give insights into the suggested dynamics of FinTech-incumbent partnership in Pakistan. Analyze the startup ecosystem, its bilateral relationship with FinTechs in Pakistan and identify gaps to make recommendations for creating necessary support for FinTechs.Review of challenges faced by FinTechs in Pakistan.

Chapter 4

Outline the model of growth of FinTech ecosystem in Pakistan and its components while ensuring the development of a self-sustaining and growing ecosystem by Karandaaz. Outline the life cycle of a FinTech member and its journey through the FinTech ecosystem. Identify FinTech verticals for investment by Karandaaz and the preferred characteristics of a FinTech business. Devise a mechanism for Karandaaz for investing in FinTechs.Identify the risks and suggest mitigation strategies for the investments.

Our analysis is based on the following:

Primary data gathered from 57 interviews conducted with senior managers from a range of industries relevant to the FinTech ecosystem – commercial and microfinance banks, mobile financial service providers, insurance companies, incubators, accelerators, FinTech technology services providers and consulting companies. Over 3000 surveys conducted of the above-mentioned industries. Insights gathered from in-depth research into global FinTech ecosystems and verticals, as well as local market reality. Use of FinSurgents’ domain expertise and knowledge base.

Digitizing the financial services value chain in the Emerging Markets will enable FinTechs to displace cash, digitize payments and document the economy.

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• Educate/counsel incumbent institutions on the FinTech partnership models.• Create FinTech acceptance in financial institutions at the management committee level.• Assist the regulator through monetary and managerial support in conducting regular conferences, round

table discussions, workshops and certifications led, hosted and supported by the regulator.• Arrange periodic engagements for regulatory bodies with other progressive regulators.19. Create Research wing in the FinTech Regulatory Wing with regular engagements of international

consultants.

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1.2 Market Context: A Peek into Pakistan

Pakistan, with the 6th largest population in the world, is predominantly a cash-based economy (PKR 2.5 trillion in circulation and increasing on a year to year basis as of June 2015) with low financial inclusion; 85% of the population does not have access to financial services in Pakistan. However, Pakistan has a growing internet and mobile penetration, presenting a unique opportunity to digitize the financial services value chain.

Pakistan’s adult literacy rate stands at 59% , which correlates with low levels of financial inclusion. However, a high percentage of cell phone ownership (132 million) and the ability of majority (59%) of adult cell phone owners to engage in at least one advanced function, presents an opportunity to provide financial services via mobile technology in Pakistan. The mobile users are relatively young in age and predominantly male with 80% of the population owning mobile phones, being below 45 years of age and 77% of them being male. Additionally, we see an equal percentage of cell phone ownership on both sides of the poverty line with 58% of the cell phone owners above the poverty line and 51% below the poverty line.

Informal financial services are also prevalent in Pakistan. At present, out of the one-third of adults borrowing money, only 3% are taking out formal loans.

However, the opportunity to provide financial services via cell phones is not equal for all segments, especially women. At present, only 2.9% of the 15% of Pakistanis with access to

1. (State Bank of Pakistan, 2015)2. (InterMedia, 2015)3. (UNESCO, 2014)4. (Pakistan Telecommunication Authority, 2016)5. (InterMedia, 2015)6. Ibid.7. (State Bank of Pakistan, 2015)

financial services are women, whereas only 29% of women in Pakistan have a cell phone as compared to 77% of men. We can, therefore, conclude that the growth of FinTechs in Pakistan highlights the opportunity for a positive impact on women.

Pakistan has invested in technology and developed a strong foundation which may allow the country to leapfrog the remaining challenges. The Pakistani market is characterized by high mobile technology adoption with a mobile teledensity* of 69%. The mobile technology landscape has seen significant growth over the last decade in Pakistan.

The influx of mobile technology is further complemented by the adoption of mobile internet with mobile internet subscribers expected to increase from 9 million in 2014 to an estimated 59 million in 2019 making Pakistan the country with the ‘fastest growing mobile internet access rates.’ The change in consumer behavior is evident as about 65% of traffic from an online real estate marketplace in Pakistan comes from the tech savvy “Millennials”, who also happen to form 75% of the social media users. About 8% of the population is connected to social media, and 46% of web traffic is coming through mobiles.

NADRA currently holds the largest biometric enabled database of the country’s population. According to NADRA officials, 92% of the adult male population and 88% of the adult female population have CNICs (Computerized National Identification Card), and NADRA biometrically authenticates all cellular subscriptions in the country. With 132 million biometrically verified SIMs, opening a mobile wallet and fulfilling a regulator’s ‘Know Your Customer’ (KYC) requirements are as easy as the click of a button. However, with NADRA charging high rates** on Verisys, an online verification system used by financial institutions for digitally verifying customers, the cost of such checks remains an impediment to the large-scale proliferation of Digital Financial Services (DFS).

Pakistan also has the building blocks for digital lending. Apart from the credit registry (eCIB) developed by the State Bank of

Pakistan (SBP), four private sector credit bureaus (Datacheck, News-VIS Credit Information Services, ICIL/ PakBizInfo, and Credit Chex) provide credit information to financial institutions. SBP introduced the new regulation for private sector credit bureaus in 2016 which will further solidify the foundation for a strong formal lending system as new credit bureaus will venture into the lending system and record both positive and negative credit history.

According to Accion, Pakistan ranks behind India, Bangladesh, Kenya, Egypt and South Africa in factors such as mobile penetration per 100 people, number of accounts at financial institutions age 15 and above and smartphone penetration age 18 and above. As the gaps in all these areas fill with time, the market opportunity for providing digital financial services will also increase and indicate the growth potential of the total opportunity.

We expect FinTechs to empower women by architecting products and propositions uniquely suited to their needs.

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8. Ibid.9. Ibid.

* No. of mobile phone subscribers per 100 inhabitants 10. (Pta.gov.pk, 2016)11. (PWC 2015)12. (Pakistani Press International, 2015)13. (Butt, 2015)

14. This is an estimate based on the last census held in 1998. 15. (Pakistan Telecommunication Authority, 2016)

** Biometric verisys is for PKR10 and non-biometric verisys ranges from PKR 30-40 based on information set retrieval.16. (State Bank of Pakistan, 2016)17. (Cheston, S., 2016).


SEEDING INNOVATION: A framework for rooting FinTechs in Pakistan 05

97% of adults have updates CNICs

13.2 million branchless banking accounts

59% literacy Rate

132 million biometrically verified sims

96% pre-paid mobile phone subscribers

15% of the population uses formal financial services, but only 2.9% of the women do

While one-third of adults borrow money, 3% borrow from a formal financial institution

13 incubators and accelerators in the country

32.7 million currently access the internet

75% social media users are Millennials

5th largest freelancer country in the world based on revenues

28 million payment cards available

6th largest population in the world: cash-based economywith low financial inclusion

200,000 active BB agents in the country

29.7 million 3G/4G subscribers

Sources: UNESCO, PTA, State Bank of Pakistan, NFIS, Invest2Innovate, InterMedia Wave 2 Report, Elance and O’Desk, Pakistan Press International, GSMA, Pew Research Center, KPMG, PWC, Business Insider.

Figure 1.1 Market Context: A Peek into Pakistan



The opportunity to reinvent the lending business seems even larger when one considers that 63% of the population does not have the savings required to deal with a financial emergency. Increasing digitization of both consumer and merchant payments can provide the data to help create credit scoring for the unserved population.

None of these drivers or enablers hold significant meaning if a robust regulatory framework does not supplement them. The financial services universe enjoys strong support from a progressive and committed regulator, leading by example in the developing world. The State Bank of Pakistan’s regulations for branchless banking are being replicated in several other developing economies. The financial universe is constantly and positively evolving owing to SBP’s commitment in the shape of various regulatory frameworks. Inter Bank Funds Transfer (IBFT), has worked to make commercial banks and branchless banking players interoperable, creating fluidity in the system. Dedicated to enhancing financial inclusion, the State Bank of Pakistan has a vision of opening 50 million mobile wallets by 2020. Another similar initiative is the ‘Asaan Account’ regulation, allowing banks to open low-risk accounts with simplified due diligence, but allowing significantly higher account limits as compared to branchless banking or basic banking accounts which were introduced by SBP in 2005.

Payments’ infrastructure in Pakistan is also improving. The growing payments and Information Communication Technology (ICT) infrastructure, and use of debit cards for online transactions through the introduction of a local payment scheme called ‘PayPak’ are complementing the rise of online businesses, marketplaces, and homegrown companies. This, in turn, is increasing economic participation of many homegrown business owners, including the under-served, female segment. The number of documented online purchases in the country has now reached US$110 million, and Pakistan’s e-retail is expected

18. (Intermedia, 2015)19. (Banking Policy and Regulations Department - State Bank of Pakistan, 2015)20. (Bain and Company)

to grow to EUR 746 million by 2019. The digital payments infrastructure is continuing to expand, with 28 million payment cards (debit, credit, and ATM) and 44,000 Point-of-Sale (POS) machines, in addition to OTC payments and cash on delivery options.

Prepaid Cards are also increasingly used by consumers who do not have access to other types of electronic payments. These aim to increase financial inclusion in the low-income and unbanked segments and give those users who are already using financial services an alternate option to make payments. Under the Electronic Fund Transfers Act 2007, SBP issued Prepaid Cards Regulations in 2016 to promote digital transactions and financial inclusion. The regulation allows banks to work with authorized agents for issuance and distribution of prepaid cards etc.

The telecom universe was pushed into a price war early on, causing a shift toward other value-added services, such as wallets and mobile internet, as ways of differentiation and customer retention. This has resulted in approximately 200,000 plus active branchless banking agents in the country and raised the consumer confidence for carrying out financial transactions at non-bank retail participants.

With benediction from progressive regulators, the necessary plumbing for digital finance has been created. The successful introduction of FinTechs becomes all the more inevitable when we look at the financial services bedrock being set up with 30 million bank accounts and 50 million mobile wallets. If branchless banking was the first act, the FinTech revolution would be unleashing new value-building on top of the first act. An ecosystem is starting to emerge with a total of 13 incubators and accelerators in the country. Market research indicates that the startup ecosystem in Pakistan will continue to grow, as many powerful players look to start their own incubators e.g.

Telenor has already started its Velocity incubator. Pakistan is a comparatively small, yet significant player in the software export market indicated by the fifth largest freelance revenue in the world of USD $850 million.

Pakistan’s financial services sector provides the necessary enablers and drivers for digitization and further growth. The high mobile phone penetration and the existing infrastructure in financial services can be the enablement factor to increase not only financial inclusion in the country but also for the adoption and growth of mobile financial services (MFS).

Global technology adoption trends are paving the way for FinTechs

In an era where technology is flourishing, business models and value chains have shifted to digital; value is created in the cloud, distributed over the internet and consumed over mobile devices. New technologies take less time to reach critical mass, superseding traditional business models much more quickly (Figure 1.2). Smartphones have taken only three years to reach critical mass, enabling internet-based software networking sites such as Facebook to achieve the same milestone in two years. Hyper-connectivity has led to widespread consumption of products and services over digital channels. However, digital distribution alone does not constitute value. This is why attempts by banks to merely digitize the distribution of their existing products and services through internet banking have not been successful. For banks, an account remains the fundamental unit of the core banking system, the design of which is dated. Although we maintain that consumer behavior is changing, and organizations need to change at a faster pace to stay relevant, the rigid structure of a traditional core banking system prevents banks from scaling and innovating. The underlying design has to be recreated to render true value. In the 21st century, such relevance comes from the power of Social,

Digital credit revolutionizes conventional lending and emerges as one of the most compelling use cases for digital payments.

Startups are expected to morph into FinTech hubs once they realize that incumbents are open for collaboration.

18

19

20

21

22

23 24

21. (Payment Systems Statistics 1st Quarter of FY16, 2016)22. (State Bank of Pakistan, 2015) 23. (Invest2Innovate, 2014)

24. FinSurgents Primary Market Research25. (Elance and Odesk, 2014)

Mobile, Analytics and Cloud technologies (SMAC stack). A FinTech provides this value by its very nature. It recreates a rigid, closed system into a flexible one with exposed Application Programming Interfaces (APIs) and changes the dynamics of consumption from fixed to variable cost through cloud computing.

New technologies diffuse faster in markets where earlier technologies were not widely adopted. In 2015, there were more than 7 billion mobile cellular subscriptions worldwide, up from less than 1 billion in 2000. It is worth noting that most of these subscriptions are in the developing world, with globally 3.2 billion people using the internet, of which 2 billion are in developing countries. Emerging markets, therefore, present the largest opportunity for FinTechs, as these markets also claim the lowest financial inclusion ratios.

1.3 Glancing over the Global FinTech Landscape

FinTechs can be classified into ‘Traditional’ and ‘Emergent’. Traditional FinTechs have historically only collaborated with incumbent financial service providers as their technology providers. However, a new category of FinTechs referred to as Emergent FinTechs has displaced financial institutions. The financial services industry had the biggest IT spend compared to other industries and the primary focus was mostly towards making the back office processes more efficient. The introduction of the world’s first Automated Teller Machine (ATM) in 1967 by Barclays is an example of the first significant milestone in the evolution of FinTechs. The ATM enhanced the customer experience by making cash withdrawals possible 24x7 as opposed to 9 to 5 banking.

While the financial services industry was diving more deeply

into its core functions of money, risk and compliance management, the world around it, especially the customer preferences were changing quickly from analog to the digital. The pace of change in consumer behavior was faster than the speed at which financial institutions were introducing digital propositions making way for technology startups to appear. These companies started to create agile business models in financial services and developed need based products while bridging the gaps between the customers and the financial service providers.

We define FinTechs as:

“Small companies and startups obsessed with redefining the financial services value chain through digitization.”

This definition of FinTechs is supported by PWC where they refer to FinTechs as small FinTech technology-focused start-ups

and new market entrants, innovating the products and services currently provided by the traditional financial services industry. FinTechs start off as small technology companies but as they mature, they come closer to being financial companies, and this transition is a challenge, best managed through the platform approach. This approach entails that the financial institutions provide compliance and treasury functions while FinTechs create more innovative propositions. The idea is gaining ground because most of the challenges faced by a FinTechs can be addressed as it matures by partnering with a bank. FinTechs can then become to banks what apps are to smartphones – a highly flexible feature resting on top of a base platform which provides

25



The opportunity to reinvent the lending business seems even larger when one considers that 63% of the population does not have the savings required to deal with a financial emergency. Increasing digitization of both consumer and merchant payments can provide the data to help create credit scoring for the unserved population.

None of these drivers or enablers hold significant meaning if a robust regulatory framework does not supplement them. The financial services universe enjoys strong support from a progressive and committed regulator, leading by example in the developing world. The State Bank of Pakistan’s regulations for branchless banking are being replicated in several other developing economies. The financial universe is constantly and positively evolving owing to SBP’s commitment in the shape of various regulatory frameworks. Inter Bank Funds Transfer (IBFT), has worked to make commercial banks and branchless banking players interoperable, creating fluidity in the system. Dedicated to enhancing financial inclusion, the State Bank of Pakistan has a vision of opening 50 million mobile wallets by 2020. Another similar initiative is the ‘Asaan Account’ regulation, allowing banks to open low-risk accounts with simplified due diligence, but allowing significantly higher account limits as compared to branchless banking or basic banking accounts which were introduced by SBP in 2005.

Payments’ infrastructure in Pakistan is also improving. The growing payments and Information Communication Technology (ICT) infrastructure, and use of debit cards for online transactions through the introduction of a local payment scheme called ‘PayPak’ are complementing the rise of online businesses, marketplaces, and homegrown companies. This, in turn, is increasing economic participation of many homegrown business owners, including the under-served, female segment. The number of documented online purchases in the country has now reached US$110 million, and Pakistan’s e-retail is expected

to grow to EUR 746 million by 2019. The digital payments infrastructure is continuing to expand, with 28 million payment cards (debit, credit, and ATM) and 44,000 Point-of-Sale (POS) machines, in addition to OTC payments and cash on delivery options.

Prepaid Cards are also increasingly used by consumers who do not have access to other types of electronic payments. These aim to increase financial inclusion in the low-income and unbanked segments and give those users who are already using financial services an alternate option to make payments. Under the Electronic Fund Transfers Act 2007, SBP issued Prepaid Cards Regulations in 2016 to promote digital transactions and financial inclusion. The regulation allows banks to work with authorized agents for issuance and distribution of prepaid cards etc.

The telecom universe was pushed into a price war early on, causing a shift toward other value-added services, such as wallets and mobile internet, as ways of differentiation and customer retention. This has resulted in approximately 200,000 plus active branchless banking agents in the country and raised the consumer confidence for carrying out financial transactions at non-bank retail participants.

With benediction from progressive regulators, the necessary plumbing for digital finance has been created. The successful introduction of FinTechs becomes all the more inevitable when we look at the financial services bedrock being set up with 30 million bank accounts and 50 million mobile wallets. If branchless banking was the first act, the FinTech revolution would be unleashing new value-building on top of the first act. An ecosystem is starting to emerge with a total of 13 incubators and accelerators in the country. Market research indicates that the startup ecosystem in Pakistan will continue to grow, as many powerful players look to start their own incubators e.g.

Telenor has already started its Velocity incubator. Pakistan is a comparatively small, yet significant player in the software export market indicated by the fifth largest freelance revenue in the world of USD $850 million.

Pakistan’s financial services sector provides the necessary enablers and drivers for digitization and further growth. The high mobile phone penetration and the existing infrastructure in financial services can be the enablement factor to increase not only financial inclusion in the country but also for the adoption and growth of mobile financial services (MFS).

Global technology adoption trends are paving the way for FinTechs

In an era where technology is flourishing, business models and value chains have shifted to digital; value is created in the cloud, distributed over the internet and consumed over mobile devices. New technologies take less time to reach critical mass, superseding traditional business models much more quickly (Figure 1.2). Smartphones have taken only three years to reach critical mass, enabling internet-based software networking sites such as Facebook to achieve the same milestone in two years. Hyper-connectivity has led to widespread consumption of products and services over digital channels. However, digital distribution alone does not constitute value. This is why attempts by banks to merely digitize the distribution of their existing products and services through internet banking have not been successful. For banks, an account remains the fundamental unit of the core banking system, the design of which is dated. Although we maintain that consumer behavior is changing, and organizations need to change at a faster pace to stay relevant, the rigid structure of a traditional core banking system prevents banks from scaling and innovating. The underlying design has to be recreated to render true value. In the 21st century, such relevance comes from the power of Social,

Mobile, Analytics and Cloud technologies (SMAC stack). A FinTech provides this value by its very nature. It recreates a rigid, closed system into a flexible one with exposed Application Programming Interfaces (APIs) and changes the dynamics of consumption from fixed to variable cost through cloud computing.

New technologies diffuse faster in markets where earlier technologies were not widely adopted. In 2015, there were more than 7 billion mobile cellular subscriptions worldwide, up from less than 1 billion in 2000. It is worth noting that most of these subscriptions are in the developing world, with globally 3.2 billion people using the internet, of which 2 billion are in developing countries. Emerging markets, therefore, present the largest opportunity for FinTechs, as these markets also claim the lowest financial inclusion ratios.

1.3 Glancing over the Global FinTech Landscape

FinTechs can be classified into ‘Traditional’ and ‘Emergent’. Traditional FinTechs have historically only collaborated with incumbent financial service providers as their technology providers. However, a new category of FinTechs referred to as Emergent FinTechs has displaced financial institutions. The financial services industry had the biggest IT spend compared to other industries and the primary focus was mostly towards making the back office processes more efficient. The introduction of the world’s first Automated Teller Machine (ATM) in 1967 by Barclays is an example of the first significant milestone in the evolution of FinTechs. The ATM enhanced the customer experience by making cash withdrawals possible 24x7 as opposed to 9 to 5 banking.

While the financial services industry was diving more deeply

26. (Cognizant, 2012)27. (International Telecommunication Union, 2015)

into its core functions of money, risk and compliance management, the world around it, especially the customer preferences were changing quickly from analog to the digital. The pace of change in consumer behavior was faster than the speed at which financial institutions were introducing digital propositions making way for technology startups to appear. These companies started to create agile business models in financial services and developed need based products while bridging the gaps between the customers and the financial service providers.

We define FinTechs as:

“Small companies and startups obsessed with redefining the financial services value chain through digitization.”

This definition of FinTechs is supported by PWC where they refer to FinTechs as small FinTech technology-focused start-ups

and new market entrants, innovating the products and services currently provided by the traditional financial services industry. FinTechs start off as small technology companies but as they mature, they come closer to being financial companies, and this transition is a challenge, best managed through the platform approach. This approach entails that the financial institutions provide compliance and treasury functions while FinTechs create more innovative propositions. The idea is gaining ground because most of the challenges faced by a FinTechs can be addressed as it matures by partnering with a bank. FinTechs can then become to banks what apps are to smartphones – a highly flexible feature resting on top of a base platform which provides

28. (Gulamhuseinwala & Kouznetsova 2014)29. (Nash, 2016)

30. (Atminventor.com, 2016)31. (PWC, 2016) 32. (Arner, Barberis, & Buckley)

26

27

28

32

29

30

Large-scale behavioral transformation occurs when large segments of societal needs are unmet.

Banks are not capable of disruptive innovation; they only make incremental innovation.

Source: PEW Research Center and FinSurgents Analysis

Figure 1.2 Technology Adoption: Years until used by one-quarter of American population

First Commercially Available Year

31



2015

$2

2.3

BN

2014

$1

2.2

BN

2013

$4

.05

BN

TOTAL GLOBAL INVESTMENT IN 2015 STOODAT $22.3 BILLION; WITH A 75% INCREASE FROM 2014. IN 2015, 94 FINTECH DEALS WERE LARGER THAN $50MCOMPARED TO 53 DEALS IN 2014 AND 15 IN 2013

Lu.com

Zhong An Insurance

Stripe

SoFi

Zenefits

One97

Credit Karma

Mozido

Klarna

Adyen

Avant

Prosper Marketplace

Oscar Insurance

Gusto

Funding Circle

China Rapid Finance

Coupa Software

Kabbage

TransferWise

$10.0

$8.0

$5.0

$5.0

$4.5

$4.0

$3.5

$2.4

$2.3

$2.0

$1.9

$1.8

$1.0

$1.0

$1.0

$1.0

$1.0

$1.0

$1.0

19FinTechUnicorns

Unicorns represent companiesvalued at $1 billion or more

Lending

Payments

Other

Median deal size per vertical (X100.000 USD)

Median Deal Size - finance

Median Deal Size - payments

Median Deal Size - virtual currency

India

JapanSin

gaporeHong K

ong

Israel

Philippin

es

Korea

Mala

ysiaThaila

nd

China

0

1

2

3

4

5

6

7

Figure 1.3 Overview of Global FinTech Investment Activity and Prominent Verticals

Source: Accenture and KPMG



1.4 Future of Digital Financial Services in Pakistan

Pakistan is largely a cash-based economy. Paper-based transactions have increased from PKR 80.68 trillion in 2010 to PKR 127 trillion by 2015. For economies to transition to a cashless society and increase financial inclusion, new technologies, government programs and customer preferences are primary factors that facilitate this shift. The infrastructure of financial services in Pakistan is in place and interoperable, but it is not positioned to reduce cash circulation substantially. The foundation of supportive Government institutions incentivizing cashless instruments via a conducive regulatory environment can fast forward the cashless journey. New technologies such as DFS and Wallets whose adoption will be encouraged by the FinTechs and service layers can achieve an inclusive economy. We have already begun to see this happen as the incumbents like MobiCash have started to expose their APIs to expand accessibility.

33. (State Bank of Pakistan, 2015)34. (MasterCard, 2013)

33

34

What mobile apps are to smartphones, FinTechs will be to financial services platforms.

Source: FinSurgents research and analysis

Figure 1.4 Different Layers of Digital Financial Services

• SBP

• PTA

• NADRA

• SECP

• BANKS

• TELCOS

FOUNDATION

DFS ASSET LAYER

• SMARTPHONE

• 3G/4G / BROADBAND

• BANK ACCOUNTS

• AGENTS

• ATMs / POS

• ID CARDS

WALLETS LAYER

• DIGITAL AND MOBILE WALLETS

• EXPOSED WALLET APIs

FINTECH LAYER

• FINTECHS

• DIGITAL BANKS

• PSPs

SERVICE LAYER

• DIGITAL LENDING

• CROWD FUNDING

• MONEY MANAGERS (PFM)



1.5 The Way Forward: Collaboration is the New Winning Strategy

The sociological, financial and technological changes around the world over the last decade have led to the creation of ‘Emergent FinTechs’. The newfound agility of emergent FinTechs, as opposed to earlier bank technology partnerships such as the ATM, was unanticipated by incumbents, who have responded defensively. However, as emergent FinTechs are better understood, traditional institutions have found an opportunity to collaborate with FinTechs. Examples include Scotiabank’s partnership with Kabbage to provide business loans and the BBVA Compass and OnDeck’s partnership for providing loans to people who do not qualify for the BBVA loan criteria. These symbiotic relationships will lead to a new phase of mutually beneficial co-existence in financial services space. However, these relationships require effort to seed, especially within developing markets where financial institutions remain content to rely on their traditional roles.

The collaboration will succeed where regulations are strongest, as the most prevalent mindset in developing markets leads to investment in only those areas explicitly allowed by the regulator. At the same time, banks are under pressure from customers who value innovation, industry analysts who criticize their complacency, and from large-scale info-com companies looking to extend their customers with financial services by introducing FinTech propositions over their platforms (Apple Pay, Google Wallet, Facebook Payments, etc.). However, traditional banking structures do not allow for the flexibility to address this threat from all sides. Banks will, therefore, have to partner with FinTechs under duress.

The mindset and skill to partner with an organization a fraction of their size are not something banks have indulged in the past. Large banks are accustomed to the status quo. Small bank and FinTechs partnerships, therefore, appear best positioned to seize the opportunity for collaboration as relationships can be developed on an equal footing. Collaborative frameworks will warrant no additional risk for the small banks as FinTechs will own CAPEX investments required to go to market in exchange for a share of the revenue earned.

2 MARKET READINESS, OPPORTUNITIES& GAPS


2 MARKET READINESS, OPPORTUNITIES& GAPS

With the world’s 5th largest young population and an increasing internet and smartphone penetration,

Pakistani consumers are now ready to adopt and consume digital services. The new use cases are

expected to be created by the FinTechs leveraging the incumbent platforms. These FinTechs will engage

not only the existing customers but also invite the unbanked to utilize these services.

MARKET READINESS, OPPORTUNITIES& GAPS2


Introduction

Market Readiness (2.1) provides an overview of the demographic, economic, infrastructural and consumer behavior factors in Pakistan’s market to determine current market readiness and the gaps and opportunities for FinTechs. Digital Financial Services Insights (2.2) offers an analysis of the financial services’ segments through secondary research to determine the role FinTechs can play in creating and promoting DFS within different sectors.Re-defining the Lens (2.3) provides a critical assessment of some of the factors through which FinTech opportunities are assessed in Pakistan.

2.1 Market Readiness

5th largest youth population offers new age financing opportunityGeneration Y, born into the digital age, adopts new technologies early. Pakistan holds the 5th largest young population in the world with a median age of 23 years. It is a potential market for the new generation of financial products and services built over Social Mobile, Cloud, and Analytics, (SMAC) that are engaging, smart, fast and effortless to use.

Low financial inclusion ratio indicates a wider canvas for digital financial servicesPakistan is a lower middle-income economy with a per capita gross national income of $1400. However, it has a much lower financial inclusion ratio of 15% compared to a 33% average for lower middle-income countries. Therefore, the opportunity for banking the unbanked and digitization of payments for the already banked make Pakistan a frontier market for DFS.

Low contribution of financial services towards GDP with a narrow focus on the top of the proverbial pyramid onlyFinancial and insurance services constitute 3.14% of Pakistan’s total GDP, compared to 5.18% for India and 6.8% for China. The banking sector represents 80% of financial services but serves only 15% of the population. The strong growth in the banking industry is achieved through investment by banks in risk-free government securities. By increasing the breadth of financial products and market reach of the financial services beyond 15% of the population, the financial services industry is expected to play a more pivotal role.

Talent in IT sector is growing but the quality is lackingPakistan has a budding growth for IT resources. There are 1,500 registered IT companies in Pakistan and 10,000 IT graduates entering the market every year. Global IT sales in Pakistan equate $2.8 billion. Information Technology services and software exported to other countries account for $1.6 billion of the total sales.

The IT industry suffers from a quality deficit in infrastructure (electricity), language barriers with foreign clients, lack of documentation of codes and processes, inadequate after sales support, a high turnover rate of skilled labor and weak intellectual property rights (IPR) enforcement.

Improving ICT accessibility through 3G/ 4G ICT forms the foundation for technology-based services and business models. Pakistan has lower ICT access than the developing world, and an even lower usage attributed to supply side factors of low per capita bandwidth and high entry level prices for fixed broadband plans. These plans cost more than 10%

of per capita Gross National Income and are considered expensive compared to the target of 5% set by the Broadband Commission. The low per capita bandwidth is likely to improve post the introduction of 3G/4G, as well as the addition of a submarine landing in 2016. While laying ICT infrastructure is the first step in reducing this divide, it will also prove to be useful with localized solutions.

Consumer movement towards mobile and social platforms Pakistan has around 32 million active internet users; at least 19.6 million of them are social media users. Out of these, around 16.2 million users access social networking via a mobile device, and this figure has grown by 113%, starting from 2014 to the end of the first quarter in 2015. Mobile devices are quickly becoming more popular and grabbing the share of web pages from laptops/desktops. 50% of Pakistan’s internet users now access web pages through a laptop/desktop, down from 66% last year.

Ease of doing business and Investment to GDP Ratio are low. Improvement in financial markets is required In 2016, Pakistan ranks at 138 among 189 countries in the ease of doing business; declining by 8 points in comparison to its rank in 2015, indicating a deteriorating regulatory environment for setting up businesses.

Pakistan, with an investment to GDP ratio of 15%, falls behind the emerging and developing economies’ investment to GDP ratio of 32%, crowding out productive private investment as a result of increased public borrowing from banks. This contributes to a low investment to GDP ratio. Thus, the development of capital markets is essential for the development of financial markets

2.2 Digital Financial Services Insights

The following section provides an overview of financial services in Pakistan to highlight opportunities for FinTechs to strengthen existing financial services while creating new Digital Financial Services.

Opportunity to leapfrog to next generation payments for the world’s 3rd largest cash-based economy Pakistan is the world’s third largest cash-based economy but the cash distribution infrastructure fares far behind global averages. Pakistan had 7.33 ATMs per 100,000 people in contrast to 18.05 in India and 49.63 in Indonesia in 2014.

ATMs require proximity to the bank branches for cash replenishment and pose a similar problem of limited scalability faced by bank branches. They also limit the liquidity of branchless banking agents relying on ATM withdrawals.

With SBP’s prepaid card regulation and the plastic card extension of m-wallets, card payments are expected to rise. However, the card payment infrastructure in Pakistan lags behind comparable countries regarding the POS machines catering to their populations. Pakistan, with a population of 186 million, has 44,000 POS machines in contrast to Turkey with 2.5 million POS machines for a population of 75 million and Iran’s 15 million POS machines for a population of 78 million. Therefore, instead of investing into age-old infrastructures of ATMs and POS machines, a focus towards m-wallets, mobile merchants and mobile points of sale (mPOS) is needed. The potential for cards and wallets presents an opportunity for Pakistan to leapfrog to the next generation of payment infrastructure while capitalizing on the growing mobile infrastructure and usage. Hence, the digital payment

infrastructure, and not the cash distribution infrastructure, will lead the transition to the new age of financial products and services.

Real use cases for m-wallets can accelerate m-wallet uptake and enhance online banking engagementThe initial aim while setting up branchless banking was to capitalize on the extensive telecom distribution network and provide banking services to the unbanked. Although a positive step, inasmuch as the agent network role has helped in the formalization of domestic remittances, branchless banking has not had the desired effect in the digitization of payment behaviors and financial inclusion in the truest sense. At the time of writing this report, 58% of wallet transactions are limited to cash deposit and withdrawal. With 132 million biometrically verified SIMs, issuing wallets is possible through the click of a button, but maintaining activity over these wallets is a challenge. In the 3rd quarter of 2015, OTC transactions accounted for almost 82% of the transactions with only 18% m-wallet payments. Over-the-Counter (OTC) transfers have been dominant because of a deliberate focus on an agent-led OTC model due to high dependency on associated revenues, and hence a reluctance to switch to digital transactions.

Primary market research results reveal that senior managers are quite optimistic about mobile wallets and their subsequent usage. They cite two reasons for the lack of customer engagement; first, mobile wallets are focused on the bottom of the pyramid whereas the top of the pyramid is where wealth is concentrated. Therefore the initial uptake and usage have been

slow. Secondly, there is a lack of consumer-focused products built on top of wallets to encourage usage beyond P2P transfers, mobile top ups and utility bills. This lack of payment types and products is an opportunity for FinTechs to create need-based use cases on top of these mobile wallets.

Additionally, digital payments need to be price sensitized or demonetized where possible, to encourage adoption of digital financial products because monetization and consumer adoption are inversely proportional.

Providing an impetus to the digitization of currency through branchless banking interoperabilityCurrently, 12 players in Pakistan have branchless banking licenses of which none has interoperability among their wallets. These include UBL, MCB, HBL, JS Bank, Bank of Punjab, Meezan Bank, Tameer Microfinance with Telenor, Waseela Microfinance with Mobilink, U-Microfinance with Ufone, Askari Bank with Zong, Bank Alfalah with Warid and FINCA with Finja. Although it is possible for an m-wallet user to make transactions to someone in the commercial banking universe via IBFT, transactions between m-wallets are not possible up till now. Lack of interoperability among m-wallets limits their utility for the most frequently used aspect of customer-oriented transactions in branchless banking, i.e., P2P money transfers. The State Bank of Pakistan’s announcement regarding the signing of a MoU with the Pakistan Telecommunication Authority (PTA) will enable interoperability between m-wallet players providing further impetus to move from cash to digital.

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Online commerce is creating a demand for enabling digitized payments Pakistan’s e-tail is expected to grow to EUR 746 million by 2019 and EUR 1.9 billion by 2024; a 2.3% penetration.

Cash payments dominate the online commerce industry. However, a truly valuable online experience and unhindered growth demand a shift to online payments. The local gateway ‘PayPak’ has been launched by 1Link to enable debit cards for online payments. Although ‘PayPak,’ has been launched to allow online debit card payments, m-wallets trump plastics (credit and debit cards) as the digital payment method for enhancing customer experience and promoting m-commerce.

M-wallets offer noticeable convenience over cards as the user can complete the transaction while staying in the same window. They allow aggregation of different payment instruments (cash and card) into one. Furthermore, the growing number of m-wallets is expected to reduce the Merchant Discount Rate (MDR) significantly and enhance online commerce.

Digital lending services can provide the missing link in formal lendingOne-third of adults in Pakistan borrow money. However, only 3% of these borrow from financial institutions. SMEs experienced a 9% reduction in available formal credit between 2009 and 2014. Private sector credit also observed a 7.3% reduction during the same period. Formal lending towards

Pakistan’s biggest industry, agriculture, is a mere 6% despite the 21% contribution to GDP from this sector. Nearly 65% of the total lending done by banks is directed towards large corporations and the government accounting for only 0.4% of the total bank borrowers in the country. However, as the transition to digital payments occurs, alternative financial information for the unbanked will become available. FinTechs building data analytics on top of alternative financial information to develop credit rating will enable formal lending to the unbanked. Formal lending will take place at all three levels – individual, small merchant, and supply chain. Digital disbursements and loan repayments will save costs. This entire process is referred to as ‘digital credit,’ and can incentivize digital payments.

Supply chain digitization can provide SME financing SMEs account for 98% of all enterprises in the country and their workforce comprises of the largest share of the rural and urban population. However, consistent with global trends, the financing needs of SMEs are largely unmet by the formal financial sector of Pakistan. 89% of working capital and 75% of investment needs are met through SMEs’ resources. There are an estimated 3.2 million SMEs in Pakistan, with banks, lending to only 6% of them. Also, SME financing has been consistently decreasing since 2008 as the SME Bank, a government-owned institution, has stopped extending new loans due to a Non-Performing Loans ratio of 82%. Digital P2P lending for supply chain differs from invoice financing and factoring and focuses on creating digital networks integrating investors, suppliers, and subcontractors to create flexible financial

networks to provide cash whenever it is needed within the supply chain. The digitization of supply chain payments via mobile wallets fosters the development of credit risk profiles of small vendors based on their payments history. The large corporations are then in a position to lend to their suppliers, further solidifying the reason for wallet based payments for small suppliers. Lending from large corporations leads to the sustainability of vendor businesses and results in stronger vendor-buyer relations and a digitized supply chain for large corporations on top of a new investment opportunity.

Insurance has a chance to become relevant and affordableInsurance coverage in Pakistan is only 7%, and the insurance sector contributes less than 1% to national GDP. Nearly half of the uninsured population in the country has never bought insurance because they deem it unaffordable. However, with the ubiquity of devices and increasingly available customer data, it is possible to make insurance more personalized. The increased connectivity of devices can keep track of a greater number of things such as the health of a person and the condition of the vehicle he/she is driving. It monitors the traffic situation in an area as well as measuring and analyzing the number of accidents in certain areas and the time at which they occur during each day to estimate the probability of an accident. Similarly, with the presence of a sharing economy where an asset might not have a single permanent owner, insurance policies of the past do not apply anymore where one flat policy worked for any time or any category of risk. Now the global industry is moving towards Pay-As-You-Go insurance models which provide coverage for certain time frames. FinTechs can help create similar insurance models in Pakistan. For example, upon the onset of a motorway journey from Lahore to Islamabad, user-based service offers the traveler the option to insure that particular trip. Given the travelers’ connectivity with a mobile wallet, their ability to pay for specific insurance for a particular event will become possible. In short, considering that the majority of the population is unable to save significant amounts

18

19

20

21

of money, such small insurances with device-led customer experiences are well suited for the Pakistani market.

Microfinance banks can be redeemed from the limitation of physical reach through digital channelsPrimary market research findings indicate that microfinance banks view physical reach or the lack of an extensive distribution system as a challenge.

The digital age has removed the difference between small and large banks by making customer access independent from a physical network. Increased access to customers can be realized through wallet based payments between the bank and its customers, and creating virtual sales teams for the distribution of products. Sales persons can become trained via a digital online certification for bank products and services. The sales team members get paid only when they go out and bring onboard new customers through their handheld devices and compensations are settled via digital payment mechanisms into the mobile accounts of agents. Furthermore, a microfinance customer should also have the option of making money by referring bank products to another client, significantly reducing the cost of introducing new products.

All banked products need to have the concept of evangelism built in their design to compete effectively. Evangelism refers to future banking products which have the capability of diffusing within the customer’s inner circle and thus forming a social network for financial transactions. By designing products where the customer is the promoter or seller, banks can reduce the resources spent on product uptake.

Digitizing International Remittances, an opportunity for FinTech led value additionPakistan is one of the top 10 markets for international remittances. Currently, beneficiaries have to go and collect remittances in cash from bank branches which pose an inconvenience.

Mobile wallets provide a limited use for remittances which increases the likelihood of beneficiaries cashing out, the remittances. With decreasing rebate amounts on the Pakistan Remittance Initiative (PRI) scheme, banks and telecom operators find their margins diminishing while using analog distribution channels. FinTechs can play a very interesting role in this vertical by digitally connecting both sides of the remittance corridors, providing relevant investment and saving products for the Pakistani Diaspora, and making need based products around mobile wallets, thus ensuring consumption of the incoming remittances through mobile wallets.

Formalizing savings by introducing need based products Pakistan’s Gross National Savings rate of 35% for 2014 is relatively low compared to the average Gross national savings rate of 43% for developing Asia.

Multiple factors account for this low level of savings in Pakistan (see Figure 2.2 for savings in the different segments), including limited access to financial markets, high propensity to consume, a high dependency ratio and low real returns on financial instruments. Another contributing factor is the lack of guidance and options for managing the wealth of individuals from formal financial Institutions; the 36% of the adults that save, only 4% save with a formal financial institution. The majority of the population of Pakistan needs cash flow smoothing products to be able to meet their monthly expenditures. The size of saving per household decreases as we move down the opportunity pyramid, however, the aggregate savings for this segment is greater than the upper quintiles.

All these factors translate into an opportunity for micro investment products with quick returns. Services such as P2P lending and crowdfunding will enable savers to find investment opportunities and the borrowers to obtain access to funds for their personal and business needs.

Opportunity to disintermediate insurance and wealth management through digitization Primary market research revealed that currently, the insurance industry works on agent models, where insurance agents receive substantial margins for selling insurance and on the collection of the first few premium payments. Significant compensation automatically follows a high activity in the initial customer cycle which dies down as the margins reduce. Similarly, investment brokers and mutual funds offering wealth management rely on banks for their distribution. To tackle the aforementioned challenges insurance companies are looking to harness the potential of technology, and mobile, in particular, to:

Reach customers and make sales via online channels to reduce onboarding costsCollect premium payments digitally

1. (UNFPA, 2014)2. (Schofield & Honore, 2010)3. (Central Intelligence Agency, 2015)4. ( Cisco,2015) 5. (World Bank, 2014)6. (State Bank of Pakistan, 2015)7. (Ministry of Finance, 2015)

8. (Statistics Time, 2015)9. (Bloomberg News, 2015) 10. (Shah, 2015)11. (Trade related technical assistance programme, 2012)12. (International Telecommunications Union, 2014)13. (PTA, 2016)14. (We Are Social, 2015)

15. Ibid.16. Ibid.17. Ibid.18. (World Bank Group, 2016)19. (Ministry of Finance, 2015)20. (International Monetary Fund, 2016)21. (International Monetary Fund 2016)

2.3 Re-Defining the Lens

The opportunity for digital financial services created by FinTechs can be correctly assessed when viewed through the right lens. This section analyzes the different indicators which color this lens by challenging some long held beliefs regarding the ratio of the urban to the rural population, the adoption of mobile technology, particularly smartphones, and the increasing trend of online commerce.

INSIGHT #1

The urban and urbanizing: Potential for FinTech adoptionConsistent with the definition of ‘urban,’ penned down in 1998, Pakistan was categorized as a predominantly rural country with only 32.5% population considered urban. Demographers have raised questions about the validity of this percentage by redefining ‘urban,’ based on which the urban population could not have been less than 40% in 1998.

According to the 1998 definition, a location is considered urban if it falls under the administrative domain of any one of the following entities:

Municipal Corporation Town Committee Cantonment

Areas that do not fulfill the specifications above are marked as rural, thus excluding the outskirts of an urban core that can be considered urban based on the following methodology defined in a study conducted in Pakistan in 2013:

Population densityPresence of a town with a population of over 50,000, Road connectivity to large cities and the presence of communication channels.

Based on this new methodology, areas that are not necessarily considered urban or rural are termed ‘urbanizing,’ as they have a decent population density, a large central town and quick access to an urban center; Pakistan is considered to be almost 73% urban or urbanizing and 27% rural.

The metal road network of Pakistan has elevated the status of previously considered rural areas to urbanizing. Pakistan holds the 20th position globally for its spread of metal roads which is expected to grow especially after the completion of the China-Pakistan Economic Corridor (CPEC). The CPEC will facilitate interconnectivity between different regions owing to the network of highways, railways, and pipelines along with energy projects underway in the project.

Thus, a greater number of small towns will have quick and easy access to big cities, positioning them to become local trade hubs for that locality.

This, along with the considerable spread of the mobile network coverage, with over 132 million subscribers, has filled the information gap that the direct cable networks such as the TV and local landlines had failed to cover (see Table 2.1 for the different uses of the mobile phone within Pakistan). As per the Pakistan Telecommunication Authority (PTA), the cellular network covers more than 92% of the land area of Pakistan. This has facilitated information provision via technology which at first was only transferred through people. The majority of the populated areas in Pakistan, which fall under the urban and urbanizing definition are connected physically and electronically and have significant mobile network coverage.

The urbanizing and urban centers of Pakistan provide FinTechs and incumbents the opportunity to construct products and services for an urban market, an advantageous position as FinTech adoption is higher on average in urban areas.

INSIGHT #2

Mobile Technology facilitating Digital AdoptionPakistan, with over 132 million mobile biometric verified connections and a mobile penetration of 69% is becoming an economy reliant on mobile phone technology. Biometrically verified connections determined by a valid CNIC mandates that all mobile connections belong to people over the age of 18. Also, a majority of these mobile connections are pre-paid; 96% of all mobile connections for the QY 2015 in Pakistan were pre-paid. Pre-paid mobile connections have facilitated the ease with which people can use mobile technology. To use a pre-paid connection, the user must be capable of purchasing a scratch card and entering the shortcode and submitting this code to top-up his/her balance amount. These users also know how to view their remaining balance, transfer their balance to another user’s mobile and subscribe for call and SMS packages that offer them the cheapest services.

People have developed a strong know-how of traversing through the USSD menus and the features provided by the mobile SIM cards. They also possess Basic English syntax allowing them to navigate their smartphones. Furthermore, in the case of G2P (Government-to-Person) payments, funds are disbursed to people living on or under the poverty line through ATM cards and wallets, to be cashed out through ATM networks and the branchless agent networks, demonstrating numerical literacy of the beneficiaries.

Based on a study conducted by CGAP to evaluate the individuals who are a part of the BISP disbursement list, it has been observed that while marked as illiterate, most (if not all) BISP recipients have a strong understanding of the English numbers. With some help, these recipients can understand and withdraw funds from agents and ATMs. This study also highlighted that the BISP recipients recognized the currency notes and their value.

The millennials also support digital adoption, as they form a majority segment of Pakistan’s population, have a literacy rate of 75% for the age group of 15 to 24. Literacy among millennials has seen a steeper upward trend over the last ten years as compared to the overall literacy rate. The high digital adoption among millennials presents significant potential for the uptake of mobile devices and the overall understanding of mobile financial services.

To conclude, even the illiterate segment in Pakistan can operate a handheld device, load, and transfer value through it and as a consequence possess a strong understanding of managing and handling currency and numbers. Pakistani consumers can learn to use different financial systems and benefit from them.

INSIGHT #3

Online commerce growth will lead to a rise in digital payments Online commerce in Pakistan is expected to grow in the next three to five years fueled by changes in the consumer experience, digital payments and a shift from the urban to the rural market.

Half of the internet users in the country are accessing the internet through mobiles which provide an opportunity for m-wallets to tap into online commerce payments. With payments through m-wallets, users will enjoy the complete online experience by seamlessly transitioning from ordering to payment without leaving the app or website window. Online commerce is promoting further growth in e-retail by providing an opportunity to Tier-2 and Tier-3 cities to participate in an online trade by selling their products to Tier-1 city buyers and purchasing merchandise not available in Tier-2 and Tier-3 cities.

On Black Friday, Daraz.pk made sales worth USD 1.3 million in a single day, with 55 times more traffic than any regular day. Black Friday also saw a significant number of orders come in

from rural areas, for example, Homeshopping.pk received 50 orders from the rural town of Tando Allahyar, as compared to the daily average of one. According to Kaymu.pk, one of the leading e-commerce businesses in Pakistan, 21% of its sales chunk was spread all over the country. About 50% of Kaymu’s orders came from the three urban centers of Lahore, Karachi, Islamabad & Rawalpindi of which 70% of the orders came from the 18 to 34 year age bracket.

Pakistan’s e-tail has a projected growth of up to EUR 600 million by 2017 and is forecast to reach 2.3% of the market by 2024.

A growing 3G/4G network, a strong logistics network of the courier companies in Pakistan and their Cash-On-Delivery (CoD) services have enabled a high sale percentage for a predominantly cash market. CoD is 95% of the overall transactions due to a lack of alternate digital methods of payment. The number of credit cards currently circulating in Pakistan (1.3 million) does not even account for 1% of the population. There are only approximately 44,000 Point-of-Sale machines in the market. However, the online payments situation is expected to improve with the introduction of escrow services by Easypaisa, the pre-paid card regulations launched by SBP and the arrival of the local payment scheme, PayPak, which will bring 25 million debit cards online.

CoD is the dominant payment method because it provides the customer protection from defective merchandise giving them the opportunity to return the ordered goods if they do not meet their expectations. This fear of dissatisfaction stems from a lack of trust and almost no consumer protection standards in the country. Although CoD is generating a high volume of sales, it is costly for merchants who have to invest in the product and delivery with no guarantee of purchase and a payout cycle of a minimum of 7 days to a maximum of 25 days from the courier companies. Two of the leading branchless banking players, EasyPaisa and UBL Omni, have stepped up to offer their agent networks as a substitute to the CoD which allow customers to make payments at the agent locations against goods purchased to help the merchants reduce operational expenses. Although

this solves the problem of customer returned goods, the issue of consumer protection needs to be addressed for e-commerce to flourish truly as delivery related frauds tend to worsen the trust deficit of the customers. Globally, regulations put in place to protect online commerce customers fostered the growth of modern day e-commerce. For example, countries such as Indonesia and Malaysia introduced regulations in 2013 and 2014 respectively strengthening customer protection laws and enacting antifraud regulation as a result of which online commerce has grown.

These countries introduced escrow systems which could handle client-merchant payments, as well as claims and disputes. Customer trust is the key factor that has led to e-commerce market growth with companies like Amazon having invested heavily in building trust by ensuring timely deliveries, quality assurances and effective return policies to gain consumer trust. The overall uptake of online shopping in Pakistan opens up growth opportunities at multiple fronts, including payment solutions, smart logistics and by creating open markets for anyone to set up shop. This will become one of the key drivers that will preempt consumers to move from the conventional cash-based approach towards a digital payment approach. As stated by the country manager for Kaymu, once customers start trusting e-commerce, it is easy for them to shift to a digital payment method by offering exclusive discounts.

INSIGHT # 4

Smartphones are capturing an increasing share of the market, aided by the growth of mobile internet servicesPakistan’s smartphone adoption rate has grown with 3.28% of smartphone connections recorded in 2011 to 16.6% in 2016. People have increasingly begun to shift from feature phones to smartphones as local companies like Q Mobile and Voice have started offering economical handsets (as low as $60). Smartphones have become the entertainment centers for watching videos, listening to songs and sharing free messages with each other using applications.

People in Pakistan have more mobile phones (69%) as compared to bank accounts (15%) which indicate their technology preference. Before the launch of 3G and 4G services in Pakistan, economical feature phones were dominant, because of a lack of high-speed internet, people did not feel the need to invest in expensive smartphones. As a result, all communication was carried out by telecoms and other organizations that were mainly based on SMS, Voice, and USSD.

However, during the last two years, because of the introduction of 3G and 4G services in 2014, people have started to see the utility in owning smartphones. In 2014, one-third of the population (31%) was a mobile subscriber in contrast to using fixed Internet (1%). Moreover, smartphone adoption is expected to rise from 16.6% in 2016 to 51% by 2020, indicating the rising trend of smartphone usage.

Along with the local smartphone companies that have invested heavily in marketing their inexpensive smartphones, telecom companies have started offering affordable smartphones,

clubbed with their internet packages, to increase the 3G and 4G uptake. Of the current 32 million internet users in Pakistan, 29 million access the internet through the 3G and 4G services indicating a high uptake of mobile internet services.

Pakistanis are increasingly adopting smartphones which are a source of information, communication, education and entertainment. Smartphones provide a robust platform and a promising future for companies to build on and thus offer their products for the 3G and 4G enabled devices.



Introduction
























Source: New York Times, National Financial Inclusion Strategy, We Are Social, World Bank

Figure 2.1 Market Readiness Online commerce is creating a demand for enabling digitized payments Pakistan’s e-tail is expected to grow to EUR 746 million by 2019 and EUR 1.9 billion by 2024; a 2.3% penetration.



















10,000

IT graduates enter market every year but quality of

IT sector is lacking

15%

80%

of the �nancial services areoffered by the banking sector,

but they serve only 15% ofthe total population

3.14%

61%

138

Pakistan’s Financial InclusionRatio is low as compared to

a 33% average ratio formiddle income countries

Contribution of �nancial andinsurance services to total

GDP, compared to 5.18% forIndia and 6.8% for China

of internet users are socialmedia users

Pakistan's ease of doingbusiness rank among 189

other countries

MarketReadiness



INSIGHT #1











INSIGHT #2






INSIGHT #3










INSIGHT # 4









Introduction


















22. (Liivak, 2015)23. (The World Bank, 2014)24. (Payment Systems Statistics 1st Quarter of FY16, 2016)







Digital payment infrastructure, and not cash distribution infrastructure, will lead the transition to the new age of financial products and services.

Branchless banking interoperability will provide further impetus to move from cash to digital.

25. (Edgar, Dunn & Company, 2015)26. (Techrasa, 2016)27. (State Bank of Pakistan, 2015)

28. (State Bank of Pakistan, 2015) 29. July-September 2015 SBP Branchless banking newsletter, indicates that 43% of

wallet transactions and 63% of OTC transactions are P2P.









29

22

23

24

26

25

27

28














INSIGHT #1











INSIGHT #2






INSIGHT #3










INSIGHT # 4









Introduction
































M-wallets trump plastics (credit and debit cards) as the digital payment method which can truly enhance customer experience and give a further boost to growing m-commerce.

As we transition to the first level of behavior change of digital payments, the next wave will be digital credit.

31

32

33

34

35 36

37

39

38

40

30

41












30. (Bain &Company)31. (State Bank of Pakistan, 2015)32. (State Bank of Pakistan, 2015)33. Ibid.34. Ibid.

35. (State Bank of Pakistan, 2015)36. SMEs face a global struggle to obtain lending even in developed countries, albeit

to a lesser degree, when compared to developing countries. A 2011 study by McKinsey highlighted that 90% of MSMEs are unserved or underserved by formal financial institutions in South Asia, whereas the figure stands at 50-60% globally.

37. (State Bank of Pakistan, 2015)38. Ibid.39. Ibid.40. Ibid.41. (State Bank of Pakistan, 2015)



INSIGHT #1











INSIGHT #2






INSIGHT #3










INSIGHT # 4









Introduction




































42. FinSurgents Primary Market Research, 201543. (Money Transfer Comparison, 2013) 44. Under PRI scheme, banks disbursing the remittance coming into Pakistan were

given 25 riyals in rebate on every transaction above USD 100. But in 2015, the





rebate was revised to 20 riyals for every transaction above USD 200. Remitter and beneficiary can not be charged any fee under this scheme.

45. (Economy Watch, 2015)46. (World Bank, 2015)

47. (State Bank of Pakistan, 2015)48. (Pakistan Bureau of Statistics, 2015)

Increased connectivity of devices has made it possible to make insurance more personalized.

Figure 2.2 Savings in different segments in Pakistan





Microfinance banks can now create virtual sales teams for the distribution of products. Sales persons can become trained via an online digital presence.

Quintile 1

Quintile 2

Quintile 3

Quintile 4

Quintile 5

PKR 1.4 billion

PKR 3.56 billion

PKR 15.9 billion

PKR 5.3 billion

PKR 2.35 billion

Banked 11%

Other formal 1%

Informal 32%

Financially Excluded 56%



INSIGHT #1











INSIGHT #2






INSIGHT #3










INSIGHT # 4







42

43

44

45

46

47

48



49. FinSurgents Primary Market Research

Introduction











































49

•



INSIGHT #1











INSIGHT #2






INSIGHT #3










INSIGHT # 4







Source: Intermedia 2015

MOBILE PHONE USES

Dial numbers on their phone

Change settings on their phone i.e. ringtone

Send/respond to text messages (SMS)

ADVANCED FUNCTIONS

Send picture messages

Follow an interactive voice menu and voice commands

Listen to audio they downloaded onto the phone

Watch a video they downloaded onto the phone

Follow a text menu such for buying airtime

Use social networks, such as Facebook and Twitter

Post pictures online, such as via Instagram

User chat application such as WhatsApp and Viber

97%

71%

60%

43%

30%

29%

28%

20%

19%

16%

16%

Used this function at least once

99%

85%

77%

61%

52%

44%

42%

36%

30%

26%

28%

Access to Mobile Money. n=484

97%

69%

58%

40%

27%

28%

26%

18%

18%

15%

14%

No Access to Mobile Money. n=3,853

Table 2.1 Mobile Phone Uses in Pakistan

•



Introduction











































Figure 2.3 Redefining the Lens

Source: UNESCO, Central Intelligence Agency, Pakistan Telecommunication Authority, GSMA Intelligence, Intermedia, Kaymu

75%Millennial literacy rate; 16% higher

than the adult literacy rate inPakistan which is 59%

16.6%smartphone penetration in Q2 2016;

expected to rise to 51% by 2020

25million debit cards will soon come

online through local paymentgateways

70% of the online e-commerce orderscome from 18 to 34 age bracket

92%of land has cellular networkcoverage, facilitating information�ow to previously disconnectedareas

20th position globally for its spread of metal roads which is expected to grow especially after the completion of the China-Pakistan Economic Corridor (CPEC)

96% of all mobile subscribers have prepaid connections, using USSD commands

59%of the adult owners engage in at

least one advance mobile function

RedefiningThe Lens



INSIGHT #1











INSIGHT #2






INSIGHT #3










INSIGHT # 4









Introduction













































INSIGHT #1











INSIGHT #2




50. (Pakistan Bureau of Statistics)51. (The Urban Unit, 2013)52. Ibid.53. Ibid.54. (Central Intelligence Agency, 2010)

55. (Markey and West, 2016)56. (Pakistan Telecommunications Authority, 2016)57. (Pakistan Telecommunication Authority, 2015)58. (EY 2015) 59. (Pakistan Telecommunication Authority, 2016)

60. (GSMA Intelligence, 2016)61. (We Are Social, 2015) 62. (Lehrer, Racher, West, Harry, 2014)



INSIGHT #3










INSIGHT # 4







•••

•••

50

51

52

53

54

55

56

57

58

59

60

62

61



Introduction













































INSIGHT #1











INSIGHT #2






INSIGHT #3










63. (UNESCO Institute for Statistics, 2014)64. (Poushter, 2016)65. (We Are Social, 2015)66. FinSurgents Market Research, 201567. (Khan A.S., 2015)

68. (MIT Technology Review Pakistan, 2015)69. (Kaymu, 2015)70. (Bain & Company)71. (Kaymu, 2015)72. (State Bank of Pakistan, 2015)

73. ( International Telecommunication Union, 2015)74. FinSurgents Primary Market Research, 201575. (Javadi, 2012)76. (yStats 2014)

INSIGHT # 4







63

64

66

73

75

76

74

72

67

68

70

69

71

65



Introduction













































INSIGHT #1











INSIGHT #2






INSIGHT #3










INSIGHT # 4





Pakistanis are increasingly adopting smartphones which are a source of information, communication, education and entertainment.



77. (GSMA Intelligence, 2016)78. (Qmobile, 2016)79. (GSMA Intelligence, 2015)

80. Ibid.81. (PTA, 2016)

77

78

79

80

81

ECOSYSTEM:RAILROADS & INFRASTRUCTURE3


3 ECOSYSTEM:RAILROADS & INFRASTRUCTURE

This chapter looks at the global trends along with local market findings in a comparative context to

arrive at the recommendations for developing a FinTech conducive environment in Pakistan. The four

key elements include:

Regulatory Measures,

Financial Institutions,

Startup Environment,

and FinTechs themselves.




Figure 3.1 FinTech Ecosystem



The Ecosystem:Railroads and Infrastructure

FinTech Ecosystems: Mature Hubs and Emergent/Nascent EnvironmentsFinTech hubs are cities around the globe where FinTech activities are concentrated. After research and comparison of FinTech hubs in both developed and developing markets on factors such as the breadth of FinTech verticals, maturity of the startup ecosystems, FinTech investment activity, and the extent of FinTech specific regulatory measures, it can be concluded that each hub can be classified into Mature and Emerging/Nascent FinTech hub based on the availability of the factors mentioned above (see Table 3.1). A mature hub is differentiated from an emerging or nascent hub by its higher level of startup and investment activity and hence, its large volume of bets (number of deals) in almost every vertical and late stage funding deals for established verticals. The FinTech ecosystem participants in a mature hub are all clearly identifiable, and their roles have evolved over time. Developed hubs usually have progressive regulators, with the government also playing an active part in promoting FinTechs across the country. The breadth of verticals with FinTech activity is greater for mature hubs which include a few very well established verticals. More verticals continue to evolve as time progresses. Mature hubs have clearly identified base regulations for the more evolved verticals e.g. P2P lending in the UK and JOBS Act in the USA for equity crowdfunding. They also include FinTech dedicated startup ecosystems that comprise of dedicated incubators, accelerators, venture capitalists, corporate ventures and innovation labs.

Emerging and/or Nascent FinTech environments do not have enough concentration of FinTech activity in one city to qualify it as a hub. Instead, it is thinly spread across multiple cities. As opposed to mature hubs, key elements are absent or underdeveloped in emerging hubs. Emerging market FinTechs are small in number, and they rely on the general startup ecosystem with very few or no FinTech dedicated incubators. Moreover, FinTechs entail fewer deals and have difficulty accessing early and late stage investment. Some nascent or emerging hubs receive support from global banks, which are usually headquartered in developed markets. This allows these hubs access to investment for promising FinTech propositions and a matching corporate focus. The government support, if

present often lacks a streamlined approach to enable growth of the ecosystem but is dominated by isolated policy interventions which are tactical in nature and therefore do not holistically impact the growth of the ecosystem.

Source: State Bank of Pakistan, Intermedia, UNESCO, UNFPA, Economy Watch, GSMA Pakistan, We Are Social , NADRA,

Demographics and Literacy Financial Services Mobile, Internet and Social Media

85% of the population is unbanked

63% of the population does not have

the savings required to deal with a

financial emergency

Only 36% of the adults save

Only 4% save with a formal financial

institution

3.2 million SMEs in Pakistan, with

banks lending to only 6% of them

32.7 million can access the internet

69% have mobile phones

16.6% have smartphones in Q2 2016;

expected to rise to 51% by 2020

8% of the population is connected to

social media of which 75% are

millennials

59% of adult mobile users use at least

one advanced functions

World’s 6th largest population and 5th

largest young population

A country of 186 million people

92% male and 88% female adults have

CNICs

32.5% population considered urban

Millennials form 27% of the

population and median age is 23 years

Overall literacy rate is 59%

•

•

•

•

•

•

•

•

•

•

•

•

•

•

•

•

Table 3.1 A Closer look into the customers in FinTech ecosystem



GovernmentSupport for

FinTechs

Financial Inclusion

Ecosystems

Concentrationof FinTech

Activity

Funding

Closed vs OpenFinancial

Institutions

MATURE

Government provides monetary support, investment, policy support (e.g. taxbenefits), and collaboration during international trade missions for FinTechecosystems. Government supports FinTechs in order to create new jobs.

Companies build FinTech services on top of an elaborate network ofexisting financial services. They work to remove customer friction, digitize payments and create innovative products.

Mature FinTech dedicated ecosystems are presently operating at anadvanced stage.

FinTech activity is high in the financial centers of the world, including NewYork, London, Hong Kong, Singapore, and Sydney. Dedicated accelerators and incubators are present, and conferences and hackathons are being held.

High funding due to higher venture capital activity

Financial institutions are open and more responsive to FinTechs, e.g. inEurope many FinTech accelerators are sponsored by banks, which havetheir own innovation labs and open their APIs to third parties.

EMERGING OR NASCENT

Governments are beginning to recognize FinTechs in emerging and nascentecosystems.

Low financial inclusion, and a key focus on digital financial services.

FinTechs rely on the general startup ecosystems, which are in their early stages, with little support from the government and the regulators.

Activities are scattered across cities and lack significant volume in onelocation. There are only a few incubators and accelerators; some regional wings from accelerators in developed hubs are present.

Focus of investment is towards areas with strong startup ecosystem and investment culture, especially in China and India. Pakistan could find itself in the group of next favorable geographies if it can receive funding.

Financial Institutions are closed off. Banks are slow to react; the first step forthem is to digitize their systems, expose APIs and create frameworks forFinTech partnerships.

Table 3.2 A comparison of the Mature and Emerging/Nascent FinTech Ecosystems



RegulatoryApproach

DedicatedFinTech Wings

Attitudeof Regulators

Considerationto Future

Technologies

Return Focus

Examples

MATURE

A preemptive approach, for example, regulators in the UK have developedP2P lending regulations, which helped increase customer confidence.

Market regulators have established dedicated FinTech wings, especially toaddress any regulatory issues in the inception stages.

The attitude of progressive regulators is proactive and flexible towards FinTech.They balance innovation and customer protection. For example,A the regulator in the UK, Singapore, and Australia have separated the regulatory wing.

A proactive approach to technologies, such as blockchain and cyber security.Initiatives for promotions of FinTechs, includes dedicated hubs, sandboxesand informal consultation.

Investment focus towards attracting investment and talent whilecompeting with other hubs

Silicon Valley, New York, London, Singapore, Sydney

EMERGING OR NASCENT

A responsive approach, e.g. P2P platforms became operational in India andChina before the regulator took notice. Regulators come at a later stage inthe FinTech cycle.

No such wings currently exist in emerging ecosystems.

FinTech focused hubs have now begun appearing. Payments are the first tobe regulated in all emerging markets.

FinTechs can only explore the complete potential of verticals once countriesprovide a favorable regulatory view on them.

Impact focus towards creating impact and inclusion and digitizationof payment behavior.

China, Brazil, India, Malaysia, Indonesia, Pakistan




3.1 Regulations: Balancing innovation with oversight

Regulations are crucial to financial services. FinTechs, because of their technological and innovative nature, require a change in the regulatory perspective. This section provides insights into the approach taken by the progressive regulators of the world for FinTechs. It then presents an overview of the current regulatory environment in Pakistan. Finally, it provides recommendations on the regulatory initiatives that can be taken for promoting FinTechs in Pakistan.

3.1.1 Global trends aiding FinTechs

Progressive regulators realize the importance of balancing oversight with innovation. Regulatory steps supporting FinTechs across the globe are discussed below.

Balancing innovation and regulation: Promoting FinTech collaboration and increasing customer confidenceRegulation has an inverse relationship with innovation; therefore, progressive regulators work to establish the right balance between control and experimentation for FinTechs to innovate and scale. Regulators promote innovation through the creation of Innovation Schemes and dedicated FinTech wings within a regulatory body, also known as Innovation Hubs. While innovation schemes identify the potential areas of focus and layout funds for supporting them, dedicated FinTech wings work in close collaboration with other departments of regulatory bodies for close observation, consultation, regulation and authorization of FinTech verticals and companies. One such example is the dedicated FinTech wing established by FCA-UK by the name of ‘Project Innovate’ which encourages new and

1. (FCA, 2015)

established businesses, both regulated and unregulated, to introduce innovative financial products and services to the market. New startups looking to work in the FinTech space are provided informal consultation by Project Innovate at the ideation stage reducing the regulatory risk for them by bringing them in line with the regulation. Figure 3.2 showcases the key regulatory initiatives globally, their approach, which ranges from highly active to passive, and the areas they impact.

Industry input: An inclusive approach to determining obstacles to innovationProgressive regulators, such as the FCA-UK, employ methods of interacting with upcoming FinTechs, to gather feedback on whether regulations are hindering innovation or nurturing it. Based on the feedback received from these players, the regulator makes adjustments to the existing regulations in order to make sure that future developments continue taking place uninterrupted. In June 2015, the FCA-UK launched a Call for Input in order to discover the exact reasons that restrict innovation and development. These specifically included rules and policies that hindered progress. The purpose of this exercise helped develop the digital and mobile solutions sector as it came up with new rules and policies that facilitate future innovations.

The two types of mindsets: Progressive and Restrictive There are two types of regulatory mindsets; the progressive mindset allows experimentation in unproven areas, and financial service providers are encouraged to innovate, but the restrictive approach does not allow any room for experimentation. The

difference in mindset stems from the fact that progressive regulators allow financial institutions to venture into spaces unless they have been explicitly restricted, and non-progressive regulators only allow activity in areas specifically approved by the regulator, leaving little room for maneuvering. Regulators with a progressive mindset are the ones that promote FinTechs. However, most emerging markets are struggling with geopolitical sensitivities due to which they have to take a conservative stand around KYC and AML controls making them appear restrictive.

Regulatory Sandbox: Flexible experimentation while minimizing risks Sandbox environments test products by limiting exposure and hence reduce risks. FCA-UK has introduced a regulatory sandbox to test unproven FinTech concepts. It allows FinTechs to make their platform available to a limited number of consumers and test their ideas within predefined parameters to implement the safeguards needed to protect consumers. It is open for non-authorized FinTechs and makes the authorization process easier. Another approach to flexible experimentation is to allow compliance teams within banks to decide the limits of their respective sandboxes, and they only approach the regulator when looking to scale. An example of such a regulator is the Monetary Authority of Singapore (MAS).

RegTech: Using technology to reduce the cost, complexity and time in regulatory reporting Due to a changing regulatory environment, new compliance regulations keep surfacing. RegTech reduces the burden of compliance by offering easy-to-integrate cloud-based solutions which work with standard data sets to create reports. These solutions can facilitate both banks and FinTechs to fulfill the transitioning regulatory requirements without incurring significant incremental costs. RegTech can create ease in regulatory reporting particularly for consumer-facing FinTechs as they have no reliance on incumbents for compliance.

2. (Call for Input: Regulatory barriers to innovation in digital and mobile solutions, 2015) 3. (FCA. “Regulatory Sandbox.” The Financial Conduct Authority, 2015)4. (FCA, 2015)

MARKET RESEARCH

finance experts believe that in ten years time finance in Pakistan will be radically transformed by technology

Favorable policies: Promoting FinTech businessesFavorable regulations work towards promoting innovation and enabling startups and small companies to devise new ways of providing financial services. The regulation of the P2P lending industry by the FCA-UK in partnership with HM Treasury is a prominent example. The UK government also announced tax efficiencies for P2P lenders and introduced requirements for banks to direct small businesses to alternative finance providers if the banks themselves can't fulfill their financing needs.

The UK Treasury has mandated all banks in the UK to open their APIs for FinTechs and has tasked an industry led Open Banking Working Group (OPWG) to come up with standards for doing so. Banks will have to open their customer data to other players to encourage innovation and competition. Through this policy, the UK Treasury has not only made the environment more favorable for FinTechs but also helped the banks stay relevant as FinTechs come on top to build innovative products and services.

International cooperation: Diminishing geographical boundaries in the digital world With the evolution of FinTechs, the paradigm of the regulator’s role is changing as they work to attract innovative ideas into the local incubators from around the world and create a footprint of local hubs beyond local markets. FCA-UK and MAS Singapore are among those looking to collaborate with other major regulators. The FCA-UK Innovation Hub has stated its desire to promote pro-innovation regulation to international standard

92%92%

1

2

3

4

setters. The end goal of this hub is to resolve and eradicate FinTech related issues in different key jurisdiction areas by undertaking a program which has been designed to build relationships with financial services regulators in different areas.



3.1 Regulations: Balancing innovation with oversight

Regulations are crucial to financial services. FinTechs, because of their technological and innovative nature, require a change in the regulatory perspective. This section provides insights into the approach taken by the progressive regulators of the world for FinTechs. It then presents an overview of the current regulatory environment in Pakistan. Finally, it provides recommendations on the regulatory initiatives that can be taken for promoting FinTechs in Pakistan.

3.1.1 Global trends aiding FinTechs

Progressive regulators realize the importance of balancing oversight with innovation. Regulatory steps supporting FinTechs across the globe are discussed below.

Balancing innovation and regulation: Promoting FinTech collaboration and increasing customer confidenceRegulation has an inverse relationship with innovation; therefore, progressive regulators work to establish the right balance between control and experimentation for FinTechs to innovate and scale. Regulators promote innovation through the creation of Innovation Schemes and dedicated FinTech wings within a regulatory body, also known as Innovation Hubs. While innovation schemes identify the potential areas of focus and layout funds for supporting them, dedicated FinTech wings work in close collaboration with other departments of regulatory bodies for close observation, consultation, regulation and authorization of FinTech verticals and companies. One such example is the dedicated FinTech wing established by FCA-UK by the name of ‘Project Innovate’ which encourages new and

established businesses, both regulated and unregulated, to introduce innovative financial products and services to the market. New startups looking to work in the FinTech space are provided informal consultation by Project Innovate at the ideation stage reducing the regulatory risk for them by bringing them in line with the regulation. Figure 3.2 showcases the key regulatory initiatives globally, their approach, which ranges from highly active to passive, and the areas they impact.

Industry input: An inclusive approach to determining obstacles to innovationProgressive regulators, such as the FCA-UK, employ methods of interacting with upcoming FinTechs, to gather feedback on whether regulations are hindering innovation or nurturing it. Based on the feedback received from these players, the regulator makes adjustments to the existing regulations in order to make sure that future developments continue taking place uninterrupted. In June 2015, the FCA-UK launched a Call for Input in order to discover the exact reasons that restrict innovation and development. These specifically included rules and policies that hindered progress. The purpose of this exercise helped develop the digital and mobile solutions sector as it came up with new rules and policies that facilitate future innovations.

The two types of mindsets: Progressive and Restrictive There are two types of regulatory mindsets; the progressive mindset allows experimentation in unproven areas, and financial service providers are encouraged to innovate, but the restrictive approach does not allow any room for experimentation. The

difference in mindset stems from the fact that progressive regulators allow financial institutions to venture into spaces unless they have been explicitly restricted, and non-progressive regulators only allow activity in areas specifically approved by the regulator, leaving little room for maneuvering. Regulators with a progressive mindset are the ones that promote FinTechs. However, most emerging markets are struggling with geopolitical sensitivities due to which they have to take a conservative stand around KYC and AML controls making them appear restrictive.

Regulatory Sandbox: Flexible experimentation while minimizing risks Sandbox environments test products by limiting exposure and hence reduce risks. FCA-UK has introduced a regulatory sandbox to test unproven FinTech concepts. It allows FinTechs to make their platform available to a limited number of consumers and test their ideas within predefined parameters to implement the safeguards needed to protect consumers. It is open for non-authorized FinTechs and makes the authorization process easier. Another approach to flexible experimentation is to allow compliance teams within banks to decide the limits of their respective sandboxes, and they only approach the regulator when looking to scale. An example of such a regulator is the Monetary Authority of Singapore (MAS).

RegTech: Using technology to reduce the cost, complexity and time in regulatory reporting Due to a changing regulatory environment, new compliance regulations keep surfacing. RegTech reduces the burden of compliance by offering easy-to-integrate cloud-based solutions which work with standard data sets to create reports. These solutions can facilitate both banks and FinTechs to fulfill the transitioning regulatory requirements without incurring significant incremental costs. RegTech can create ease in regulatory reporting particularly for consumer-facing FinTechs as they have no reliance on incumbents for compliance.

Favorable policies: Promoting FinTech businessesFavorable regulations work towards promoting innovation and enabling startups and small companies to devise new ways of providing financial services. The regulation of the P2P lending industry by the FCA-UK in partnership with HM Treasury is a prominent example. The UK government also announced tax efficiencies for P2P lenders and introduced requirements for banks to direct small businesses to alternative finance providers if the banks themselves can't fulfill their financing needs.

The UK Treasury has mandated all banks in the UK to open their APIs for FinTechs and has tasked an industry led Open Banking Working Group (OPWG) to come up with standards for doing so. Banks will have to open their customer data to other players to encourage innovation and competition. Through this policy, the UK Treasury has not only made the environment more favorable for FinTechs but also helped the banks stay relevant as FinTechs come on top to build innovative products and services.

International cooperation: Diminishing geographical boundaries in the digital world With the evolution of FinTechs, the paradigm of the regulator’s role is changing as they work to attract innovative ideas into the local incubators from around the world and create a footprint of local hubs beyond local markets. FCA-UK and MAS Singapore are among those looking to collaborate with other major regulators. The FCA-UK Innovation Hub has stated its desire to promote pro-innovation regulation to international standard

consider Government support as being absent for the FinTech sector57%57%

5

6

5. (FCA, 2015)6. (Open Data Institute, 2015)

7. (Financier Worldwide, 2016)

setters. The end goal of this hub is to resolve and eradicate FinTech related issues in different key jurisdiction areas by undertaking a program which has been designed to build relationships with financial services regulators in different areas. 7



Figure 3.2 Key Regulatory Initiatives in Developed and Emerging Countries

Source: FinSurgents data compilation and analysis

Ecosystem Development

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Risk Reduction +Consumer Protection

Facilitating Innovation

Financial Inclusion

EmergingDevelopedPro Active

Active

Moderate

Passive

Developed CountriesAustralia

Australia’s Financial System Inquiry Report

Government Investment in digital authentication systems

Government funding for online portal for crowdsourced equity

funding companies

ASIC to work with FinTech accelerators in the region

Australian Senate's Exploration on potential of Bitcoin

Robo Advice review committee in ASIC

Australian Equity Crowdfunding legislation review

Australian P2P lending regulatory approach

Australian Securities and Exchange Commission Innovation Hub

Australian Digital Finance Advisory Committee

Singapore

Singapore Financial Sector Technology & Innovation (FSTI) Scheme

Singapore FinTech Innovation Group (FTIG)

Monetary Authority Singapore plans to regulate virtual currency

intermediaries for money laundering and terrorist financing risks

Singapore Equity Crowdfunding - treatment under securities law

United Kingdom

UK FCA Project Innovate

FCA UK regulatory sandbox

FCA UK Call for Input

FCA UK Principles for Business for P2P Lending businesses

Govt's Enterprise Investment Scheme and Seed Enterprise Investment

Scheme

UK FCA’s Innovation Hub International cooperation

RegTech by FCA UK

FCA UK Fintech informal consultation service

Special regulation exists for Equity Crowdfunding

Payment Services Regulator

FCA UK Asset Management Observation

Emerging CountriesIndonesia

Indonesia E-Commerce Roadmap

Financial Service Authority of Indonesia's guidance on investment in tech

startups

Mandiri Bank (state owned) allowed running venture fund for investment in

e-commerce gateway FinTechs

India

Issuance of 11 payment bank licenses in India

20-year plan to promote financial inclusion

Jan Dhan scheme (bank accounts for the unbanked)

People Money Scheme

Aadhaar enrollment

RBI releases Consultation Paper on Peer to Peer Lending

Reserve Bank of India suggestion to innovators to seek consultation

Close supervision of cryptocurrencies by Reserve Bank of India

India's Equity Crowdfunding to have no likely specific regulation

Hong Kong

Hong Kong's Policy blueprint for financial technology hub

Hong Kong Innovation and Technology Fund and Enterprise support scheme

Hong Kong Stored Value Facilities regulation

Equity Crowdfunding in Hong Kong - no particular regulation

China

China's Internet finance: Cross-border payment license for third parties

China’s Banking Regulatory Commission's draft rules for turbulent P2P

Lending sector

Chinese State Council's backing for alternative financing and crowdfunding

The internet (online) insurance license

China's Internet finance - payment licenses for internet/e-commerce

companies

Pakistan

Regulation for private sector credit bureaus (2016)

Prepaid Cards Regulations in 2016

Branchless Banking Regulation

Payment Service Provider/Payment Service Operator Regulation

MoU between State Bank of Pakistan (SBP) and Pakistan

Telecommunication Authority (PTA) to enable root level interoperability

between mobile wallet players

Asaan Account Regulation

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3.1.2 Pakistan’s Current Regulatory Environment

PSP’s and PSO’s to act as platforms for FinTechsThe regulations covering Payment System Operators (PSOs) and Payment Service Providers (PSPs) were released by the State Bank of Pakistan in 2014 and apply to all those entities that wish to become licensed operators for Payment Systems in Pakistan. PSPs and PSOs granted licenses to develop an electronic platform for the clearing, processing, routing and switching of electronic transactions. A PSP/PSO can make agreements with banks and financial institutions, as well as any other PSOs and PSPs, merchants, e-commerce service providers, and other companies for the provision of services mandated to the PSO and PSP under these regulations. Therefore, PSPs and PSOs are expected to act as platforms for FinTechs.

Moreover, going forward, by reducing the capital requirements for PSO/PSP licenses, the SBP can promote healthy competition by lowering entry barriers which will encourage innovation in the payments vertical.

Focus of the State Bank of Pakistan The State Bank of Pakistan (SBP) is playing a proactive role towards increasing financial inclusion through various initiatives. Branchless banking was the first such regulation that

allowed the provision of banking services without laying out an extensive branch network. It capitalized on the extensive distribution network of telecom operators. Currently, nine players with branchless banking licenses are operating commercially or are in the pilot stage with different business models. Various versions have been possible due to the flexibility in this regulation.

SBP recently released an additional regulation for creating more opportunities for financial inclusion by introducing a banking product, the Asaan Account. This regulation allows banks to incorporate simplified due diligence lower value accounts into their portfolios. It promotes convenience and accessibility to open bank accounts with financial institutions. Individuals now only require their CNIC (Computerized National Identity Cards) and an initial deposit of PKR 100 to open up a bank account. The reduced account opening requirements are expected to drive financial inclusion and motivate people in the lowest social strata to seek financial services with banks. Banks can also add more services to these accounts if they feel the need. Through Asaan Accounts, paper-based requirements for opening accounts will decrease. This category should be extended to the merchant and branchless banking customers to allow them to maintain higher deposit balances than currently available under the branchless banking framework.

Table 3.3 outlines the advantages and disadvantages of the various regulatory initiatives by SBP.

Regulations facilitate financial institutions but restrict small companiesPakistan, due to its socio-economic conditions, has put in much effort in bringing forth strong regulatory frameworks concerning financial services. As a result, it has relatively mature regulations that provide strong controls and guidelines based upon which financial institutions can operate (see Table 3.3). However, such regulations also pose barriers to entry for small organizations in the financial services.

An example of an entry barrier for small players is the high capital requirement for payment licenses - minimum paid-up

capital requirement for all those entities that seek to become a PSP or PSO stands at PKR 200 million. Moreover, FinTechs trying to register independently in Pakistan, face problems in registration. Currently, FinTechs are registering as technology and service providers as there is no separate category for FinTechs.

8. (State Bank of Pakistan, 2014)9. FinSurgents Market Research

10. (State Bank of Pakistan, 2016)11. (State Bank of Pakistan, 2015)

12. (State Bank of Pakistan, 2014)

consider regulations as being favorable65%65%

consider that Regulatory uncertainty exists around financial technology products and services

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3.1.3 Recommendations

Recommendation # 1

Banks acting as platforms take the regulatory burden while FinTechs innovateWith an 85% unbanked population, the gaps left by the banks in Pakistan are significant. Although it was possible for the telecom operators to disrupt the financial services space, non-financial institutions perceive it difficult to pursue financial services owing to the strong regulations in Pakistan as a result of geopolitical sensitivities. The market research showed that the established players are of the opinion that the current regulation poses no hindrance to FinTechs. However, FinTechs, technology and startup sectors consider the current regulations unfavorable for small players because of substantial capital requirements for licenses such as PSO/PSP. Similarly, FinTechs have to register as IT service provider companies as they are not recognized as a separate category.

Considering the prevalent compliance scenario in Pakistan and the nascent FinTech ecosystem, FinTechs working on top of banks and banks acting as platforms are more likely to yield the best results at this stage. The banks will take away the regulatory burden from FinTechs while providing them with a mature compliance environment. Large and small banks, insurance providers, and PSO and PSP license holders can all act as platforms for FinTechs. The platform approach will prevent the oversight burden on the regulator from increasing proportionally with an increase in the number of FinTechs, as the regulator only oversees the license holders.

Recommendation # 2

Clear directives for the two types of FinTech modelsThere are two ways for FinTechs to reach the consumers; they can face the customers directly while coming in direct competition with financial institutions or they can collaborate


BRANCHLESS BANKING

PSP/PSO

ASAAN ACCOUNT

Regulation Pros Cons

Elaborate framework

Well-defined product offerings

Role definition for each player

Strong AML and risk guidelines with well-defined

KYCs for all product types

Opens up doors for new players to enter the

financial space and offer payment services through

digital channels

Allows for business model innovation with different

players attacking the market with different thinking

Relaxed KYCs for bank accounts

Allow for fully digital account opening by the use of

bio-verisys facilities by NADRA

Instant customer gratification

Mandatory banking license

Does not allow for utilizing cloud-based services;

physical servers in bank premises required

Slow uptake unlike mobile proliferation in Pakistan

High onboarding friction

High capital requirement (USD 2 million) for acquiring

license which is a barrier to entry for new startups and

FinTechs.

Restricts holding customer funds to banks, stored value

services not permitted to PSPs.

Limited to banks only and bank staff required for

account opening

Overlaps with the branchless banking offering,

specifically level 1 wallets as this provides much higher

usage with similar KYC requirements

Mandatory one bank branch visit for initial deposit &

checkbook collection

Table 3.3 Advantages and Disadvantages of Regulatory Initiatives in Pakistanwith banks to utilize their existing compliance and money management setup while focusing purely on value creation. However, for the regulator, it is important to lay out the terms and conditions for FinTechs looking to adopt either of these two models. Currently, FinTechs have not been recognized anywhere in the regulatory ambit, and hence no relevant framework exists in Pakistan. The State Bank can regulate FinTechs in many ways:

Forming a clear directive for collaborative FinTechs looking to work with banksThe regulator can issue a clear framework for collaborative FinTechs i.e. FinTechs working on top of banks. This will reduce regulatory ambiguity in operations without worrying about compliance and regulations in partnership with regulated entities, such as the PSPs, switches, gateways and commercial and microfinance banks.

Forming a separate directive for FinTechs looking to face consumers Clear guidelines also need to be established for consumer-facing FinTechs wanting to go out and work independently. The minimum requirements for the customer facing FinTechs can be higher than for FinTechs working with banks. Customer facing FinTechs can pose a higher risk.

Recommendation # 3

Creating a dedicated FinTech Regulatory wingAs discussed in global trends, all progressive regulators have formed dedicated FinTech wings which work closely with the rest of the regulatory setup (e.g. NADRA, PTA, and SECP) but are agile enough to furnish the needs of nimble startups. The State Bank of Pakistan, a progressive regulator, should also have a dedicated FinTech wing to manage the two kinds FinTechs mentioned above. This wing should have a chief who reports

directly to the Governor of State Bank. The various functions that can be taken up by this dedicated FinTech wing are as follows:

Functions of a dedicated FinTech Wing

Developing and maintaining a regulatory framework for the FinTechs working in Pakistan. Providing guidance and advisory services for FinTechs through appointments and walk-in sessions.Arranging regular conferences, roundtable discussions, workshops, and certifications, led, hosted and supported by SBP.Maintaining periodic engagements between SBP resource persons and progressive regulators.Creating a revolving panel of local/international consultants advising the SBP regarding regulations and the global FinTech landscape.Facilitating industry input.Developing a regulatory sandbox.Creating an educational wing for FinTech dissemination.

3.2 Financial Institutions

Financial institutions are a key stakeholder in the FinTech ecosystem. This section provides insights into the dynamics of the partnership between FinTechs and incumbent institutions, which can prove beneficial for both. It then discusses the primary market research findings to highlight the outlook of incumbents on FinTechs including perceptions, challenges, and views on collaboration with small technology companies digitizing financial services. Finally, this section presents recommendations on steps which can increase the level of awareness and acceptability regarding FinTechs and make collaboration between incumbents and FinTechs easier.

3.2.1 Insights

De-hinging financial services innovation from legacy structures

Large organizational structures pose a hurdle in innovation because of their focus on existing business models. FinSurgents

market research indicates that at the organizational level within financial institutions there is a lack of understanding regarding FinTechs and the value offered by them which poses challenges during the internal selling of FinTech propositions. Therefore, there is a need within financial institutions to align their internal culture and structures to be acceptable towards technology led

business models, as opposed to conventional branch led business models.

The traditional banking platforms are not geared for managing frequent design updates associated with the high-tech, high engagement consumer products. According to FinSurgents primary research, senior bankers were of the opinion that the organizational structures of banks are designed in silos. Organizational verticals are based on individual product segments, and no single vertical has a complete view of the customer. The customer data is distributed across various disconnected systems. Therefore, this silo approach makes the introduction of new propositions challenging and it becomes increasingly important to de-hinge the entire process of innovation, both in design and decision, from the legacy banking organizational and technology platforms. If FinTechs are provided access to a bank’s assets – platforms and customers - they can take the product design along with peripheral procedures such as data analytics outside of the banking platforms and allow the creation of innovative products.

Banks will need to instill change from the top-down and reach the bottom of the pyramid by introducing products and value propositions that appeal to their existing customers, who then promote them to the bottom. For this banks will have to truly

engage their customers by building products on the Social, Mobile, Analytic and Cloud model (the SMAC Stack). SMAC represents the fifth and latest wave in corporate IT and is currently implemented by digital champions including Facebook, Google, Amazon, Wikipedia, etc. The four ages in corporate IT before the SMAC stack – the mainframe, the minicomputer, client/server and the Internet - have resulted in businesses achieving greater productivity by supporting a ‘killer app’ e.g. online commerce through the Internet. However, after a given period, the benefits from these technologies start to plateau until a new age arrives. SMAC stack is the new age in corporate technology and will create significant value on both the demand and supply sides. However, SMAC needs to be seen as a stack, where individual pillars cannot be implemented in isolation and need to work collectively to create real impact. For innovation to occur effectively in the financial services industry in Pakistan, the process of SMAC Stacking needs to move out of traditional structures and into lean, agile organizations with access to incumbent platforms. Financial institutions in general, therefore, need to work with FinTechs to introduce SMAC Stack products to stay relevant in the knowledge era. They will need to grant access to their APIs and form frameworks for FinTech Partnerships. The SMAC enabled financial services, and products will be personalized through the use of analytics and enable their traditional customer base to tap into the banking system at a higher frequency to drive greater engagement. Furthermore, built-in evangelism in these products will allow customers to refer these products to their social circle in a frictionless manner. Products lacking the network effect will have a high acquisition cost and will not be able to compete effectively in today’s digital world. The SMAC stack will be able to effectively disrupt antiquated organizational structures and business models of the Industrial Age.

We have used banks as an example in the above discussion, but it is important to point out that the above theory of SMAC applies

to all incumbent institutions, including insurance companies and Mobile Financial Service (MFS) providers. In the figure above (Figure 3.3), FinTechs coming on top of incumbents will automatically introduce the SMAC stack and incumbents do not

have to reorganize themselves to benefit from the fifth wave.

FinTechs have shifted partnership dynamics from licensing to profit sharing FinTechs have shifted the partnership model from licensing to profit sharing. FinTechs, by their design, rely on technologies such as cloud computing and digital distribution through mobile applications and have a much lower cost base than incumbent businesses. Banks will have to make themselves FinTech ready by making their APIs available. Popular FinTech models are supply side and have no Capital Expenditure (CAPEX) in partnerships by design. Any potential upside can be shared between banks and FinTechs, and the FinTech can absorb the downside. Hence, if the proposition offered by the FinTech has no uptake, there is little to no cost or risk to the bank. FinTechs have variable cost structures with cloud-based platforms to avoid CAPEX, and their nimble structure makes breaking even relatively easier.

This, along with other aspects of FinTech partnership dynamics, needs to be coached to different industries.

Banks and FinTechs have an independent relationship

As FinTechs accumulate customers, they have started tapping into new segments. For example, P2P lending companies are adding niche segments such as students and small businesses to their customer base. This results in an increased demand on core financial service functions, such as compliance, risk management, and others, and this could render a FinTech inefficient because of the high cost and resource requirements.

Thus, a new realization has emerged that FinTechs are not here to displace banks but that FinTechs and banks work best in unison, with banks being the core platform, providing all the necessary legacy functions. It can be deduced that the next wave of FinTech will see ‘marketplace banks,' which will compete with other banks to provide core services over open APIs to third parties for developing innovative products and business models. These banks will be characterized by a purely digital core banking system, a set of exposed APIs open to third parties, and a set of products and services offered by third parties or FinTechs.

Since financial services platforms focus on efficiently carrying out the core industry processes and achieving economies of scale, differentiation within the same framework is not possible. Incumbents across industries realize that innovation rarely happens in large, rigid structures where trying out something new could prove detrimental to Business as Usual (BAU). Innovation, therefore, has to be sourced from outside of the financial institution. The best bet for these platforms is to open themselves up to third parties for innovation, which are almost always startups. Startups are free of legacy systems and red tape and can access innovative talent driven by unique ideas and

solutions. These third parties can experiment with the core platform and develop products and services on top of these platforms.

Therefore, the best option for FinTechs is to partner with financial institutions as their strengths and weaknesses are complimentary. A reasonable assumption is that future banks will act similarly to mobile phone platforms (iOS, Android, etc.), which opened up their platforms to thousands of developers who created innovative apps, some of which were ‘killer apps’. The mobile phone stopped simply being a device for calling and

is now being used to perform multiple functions due to the bottom-up innovation which encouraged people to think differently and come up with unique solutions in the shape of mobile apps. Growth in mobile applications has strengthened the ecosystems (for iOS and Androids) themselves. Another significant trend in the FinTech space is connectivity, which can partly be created through open APIs and partly through the availability of applications over all available user channels/platforms which come through the ubiquity of solutions facilitated by open platforms.

Hence, it can be concluded that for all practical purposes, an independent relationship between FinTechs and banks is the right approach, resulting from the maturity of industry reasoning, and experience with FinTechs. The ecosystem has stabilized at this new configuration, with banks as platforms and FinTechs as differentiators, which will continue for the foreseeable future.

Small banks - FinTech Partnerships to lead the process of reducing transaction chargesConsumer behavioral change for digital products is at the very core of a FinTech revolution. However, skepticism on technology adoption is only limited to financial services in Pakistan. There is a high penetration of smartphones and subsequently, a high uptake of Over-The-Top (OTT) social and communication platforms which are free of charge. Hence, any investment into the FinTech ecosystem has to focus on inexpensive/almost free digital transactions. It is observed that large incumbent organizations are highly sensitive to changes in their quarter-to-quarter bottom line, and hence changing settled revenue models poses a significant challenge. It is therefore highly unlikely for incumbent organizations to reduce transaction charges for the real behavior changing transactions, i.e., customer-to-merchant transactions. The most suited entities for this line of action are new players who presently do not depend on transaction charges for their revenues and small banks fit this description. It is expected that inexpensive or almost free payments will fast forward consumer preferences in digital financial services in a similar vein to what WhatsApp did

for communication. Therefore, it will be prudent for FinTechs to work on a similar model with small banks which are not clocking transaction linked revenue. As this model picks up its adoption pace, incumbents are sure to follow suit. Other advantages of small bank-FinTech partnerships include partnerships on an equal footing which increases their likelihood of success in the short run and makes them a sound investment option, with friendlier organizational structures and a greater ability to collaborate.

Eliminating connection between incumbent acceptance and small companies’ survival Large firms with access to a large customer base are crucial partners in the survival of small companies. This leverage over small technology companies creates an unequal relationship, which is similar to FinTech-Incumbent partnerships. The lack of collaboration between FinTechs and large organizations could delay FinTech growth as startups by their very nature require a certain growth trajectory to come out of the startup phase, grow in valuation and become sustainable. Many useful concepts could die at the very first stage of a startup lifecycle if unable to find the necessary support.

Creating winning examples Multiple bets on several ideas, some of which are successful, will set an example for the rest of the players to follow. Presently, very few believe that a non-bank startup can come into the financial services space. A focused approach is required by a

neutral entity with strong muscle in the form of regulatory legitimacy, relationships, and capability to influence the mindset of existing players, so they invest in multiple non-competing sectors. In doing so, some of these are bound to succeed.

‘FinTech collaboration is inevitable’ for large players, but the small players have a different perceptionAlthough the established telecom and banking players indicate an increasingly open attitude towards partnering with FinTechs, the perception among other segments is different. During a market research conducted as part of the FinTech Pakistan Survey 2016, respondents from telecom, commercial and microfinance banking ranked ‘lack of interest from large organizations to partner, collaborate or invest with small firms’ as one of the top challenges faced by small startups and technology companies looking to digitize the financial services value chain. This belief stems from a prevalent vendor-buyer relationship of established players and small technology companies in the past in Pakistan, which has trickled into the FinTech space. Established players perceive FinTechs as vendors and not partners. FinTechs report that incumbents are unable to view them as equals and demand vendor-buyer arrangements under exclusivity which can be detrimental to FinTechs as it impedes the ability to scale efficiently.

3.2.2 Findings

This section discusses the findings of the primary market research whose respondents included professionals from commercial and microfinance banks, MFS providers or telecoms, and insurance companies.

Large players are keen on owning FinTech incubators, but internal challenges can hinder executionDriven by the pressures to address the perceived FinTech threat, many large players, especially banks/MFS, are considering starting their incubators. Primary research shows that banks are faced with multiple challenges internally when capitalizing on technology related opportunities, which stretches them thin

before they can turn to external opportunities. Firstly, banks have been unable to take advantage of technology related opportunities because they lack the human resource to manage such projects and ventures. Secondly, banks operate bureaucratically and are designed in silos which impede any real progress. Therefore, all such efforts have a low probability of success. Thirdly, large organizations have an unaccommodating attitude towards small companies besides requiring exclusivity agreements from them. They are also looking to build, transfer, and operate models, which makes them less conducive to play a positive role towards small companies, including any startups they incubated. Fourthly, the focus of managers within large organizations towards their functional bottom and top lines, and the association of compensation systems with these KPIs prevents them from looking at such new disruptive ventures with an open mind.

View on FinTech collaboration challenges varies with FinTech readinessProgressive players across all industries, who rank high on FinTech readiness, are open towards FinTech collaborations but are unanimous in their opinion that there are currently insufficient FinTechs in Pakistan to make partner. However, for players who rank lower in FinTech readiness, the cited challenge towards FinTech collaboration is a lack of comprehension of the dynamics of FinTechs, and to some extent, a lack of will, needed to partner with FinTechs. Besides, these organizations also cite challenges, such as insufficient capital for benefitting from technology related opportunities, a lack of understanding about FinTechs at C-level and skeptic views on consumer adoption.

Banks face talent shortage to capitalize on technology-related opportunities and consider FinTechs as a talent sourceBanks face the problem of long gestation periods even when they identify an opportunity that renders them uncompetitive in the modern era. One reason, amongst others, includes the rigid organizational structures as already discussed. Another reason is the relevant talent inside banks to capitalize on technology related opportunities. Most of the respondents, therefore, consider FinTechs a useful way to access innovative talent that is lacking in-house.

Insurance companies see themselves as technology driven, but they have a limited outlook on FinTech collaboration areas Insurance companies consider themselves as highly driven by technology and looking to invest in and engage with FinTechs through active research. The insurance industry is of the opinion that the challenges faced by insurance in an emerging market context fall under the category of ‘digital outreach and effective utilization of technology with regards to distribution of insurance policies’ and customer onboarding; a high-cost area presently. Therefore, their view of FinTechs is skewed towards a vendor mindset.

Financial technology companies are more open to cross-industry collaborations

Partnerships between small technology companies digitizing the financial services value chain and tech-centric industries, such as telecom and technology platform providers, show the most encouraging attitudes. The high dependence of banks on traditional technology platform providers has resulted in secure revenue streams for the later in the past with little motivation to innovate beyond ATM, POS, and core banking systems. As a result, their organizations have become vulnerable to FinTech disruption and these companies are actively looking to collaborate with FinTechs to overcome this threat.

Telecoms are more inclined towards FinTech collaboration Telecom operators are opening up to FinTechs, for example,

Mobicash, and Telenor have exposed their APIs to FinTechs. Historically, partnerships between large banks and MFS providers have not been fruitful owing to the large bureaucratic structures of both types of organizations. Most MFS players have acquired small banks, but this partnership is not on an equal footing either.

However, MFS providers have inherited the attitude of working with small technology companies from their GSM origins. In an attempt to increase consumption of voice over telecom networks and to differentiate themselves from their aggressive competitors, telecom operators have relied on third parties to source Value Added Services. As they have reached full market penetration and have been disrupted by OTT communication players, telecom players are at ease with disruptive, innovative

technology companies and with opening up their platforms to small players via APIs to develop unique products.


FinTech coaching for all playersCoaching regarding the dynamics of FinTech propositions and partnerships is required for all surveyed industries to rectify false perceptions and a conservative mindset, improve their FinTech readiness and trigger a process of FinTech opportunity capitalization. It is also worthwhile to consider the threat posed by international FinTechs to the local market if timely action is not taken to meet customer needs optimally. These international FinTechs, with proven business models, could enter the market and disrupt the incumbents forcing them into less than beneficial partnerships (if offered at all), in contrast to partnerships that could be made willingly and in time with local FinTechs. However, the first hurdle in this scenario is the prevalent mindset within the incumbent players’ community. With a functional focus towards established revenue models, managers do not want to jeopardize their means of compensation by introducing new products, which not only threaten existing revenue lines but also take the time to gain traction. Therefore, coaching at the board level is required to align the performance KPIs of the banks towards optimally

meeting customer needs, even if it demands to enter into partnerships with FinTechs. A successful FinTech collaboration demands to be strategic in nature, as opposed to a vendor-buyer relationship which entails the need for an understanding of the value proposition of FinTechs and buy-in at a higher level to ensure a long term and organizational strategic partnership. For details on coaching, see Chapter 4.

Building FinTech awareness programs and collaboration platforms FinTech awareness programs are needed for all sectors of the financial technology ecosystem and across all tiers of the organization within the ecosystems. Moreover, similar to progressive FinTech hubs, FinTech collaboration platforms are required, which connect available FinTechs with interested partners and investors.

Eliminating the regulatory ambiguity Although technology industries display the most conducive attitude when it comes to partnerships with FinTechs, they are faced with a regulatory uncertainty when stepping into the financial services realm.

Need for a FinTech consortium Problems indicated by incumbents and FinTechs, clarity on partnership models and a lack of interest from large organizations specify the need for a platform or a FinTech consortium. This platform will not only help small FinTech companies get connected with potential partner organizations but also provides guidance to both FinTechs and incumbents on commercial models which are viable for both sides.

3.3 Startup Environment

The startup environment is an essential building block of the FinTech ecosystem. Its strength directly contributes to the robustness of the FinTech hub. This section provides insights into the role of FinTechs in the growth of the startup ecosystem and vice versa. It also shares secondary research findings on the salient characteristic of the startup environment in Pakistan. This section concludes with recommendations related to FinTech startups.

3.3.1 Insights

FinTech growth leads to next phase of startup revolution Startups by their very definition rely on technology to reach a larger market than generally possible for small businesses. Revenue generation is an important part of any business model and digital models entail digital payments. Startups looking to adopt digital business models in Pakistan face growth challenges because of a heavy reliance on cash-on-delivery or account transfers, among other things. Such analog payment mechanisms limit not only the market they cater to but also lower sales because of the hassle involved with the customer.

With 95% of transactions in online businesses taking place through cash-on-delivery, lack of online payment methods poses a hurdle in growth. Similarly, subscription models are not supported due to lack of a subscription payment mechanism in Pakistan. FinTechs creating digital payment methods will enable startups to reach a wide market and hence FinTech growth will lead to startup growth.

So far Pakistan has been a weak breeding ground for FinTechs Several gaps prevalent in the existing FinTech ecosystem in

Pakistan contribute towards a lack of FinTechs. Market research shows the top reasons include discouraging attitudes of large companies for partnerships and a perceived difficult regulatory environment for small companies looking to provide digital financial services. When a young entrepreneur looks for options to start his own business, areas with the least regulatory hurdles are preferred to minimize risks. Due to the uncertainty of the regulation-laden financial services space, the risks posed are too high for a tech entrepreneur to venture into it.

In addition to this, market research also shows that seed investment or early stage funding in Pakistan was ranked as a challenge by the FinTech sector, startups and established technology platform providers.

3.3.2 Findings

The startup ecosystem in Pakistan is currently emergent, but it is gaining pace So far FinTechs are geographically concentrated in the cities of Karachi and Lahore (see Table 3.4 and 3.5)Accelerators and incubators are scattered across four cities – Karachi, Lahore, Islamabad, and Peshawar According to startups and banks, there is a lack of collaboration platforms in Pakistan where FinTechs and incumbents can come together Startup incubators see very few entrepreneurs interested in financial services products because of the perceived regulatory uncertainty around this space and recommend the same to incubated startupsStartup activity is thriving in the software and services sector of PakistanStartup funding is mostly local and at an early stage, but there appear to be early signs of international VC funding coming to Pakistan (see Table 3.6 and 3.7)




Recommendation # 1



Recommendation # 2


with banks to utilize their existing compliance and money management setup while focusing purely on value creation. However, for the regulator, it is important to lay out the terms and conditions for FinTechs looking to adopt either of these two models. Currently, FinTechs have not been recognized anywhere in the regulatory ambit, and hence no relevant framework exists in Pakistan. The State Bank can regulate FinTechs in many ways:



Recommendation # 3







3.2.1 Insights















1

1.

2.

3.

4.

5.

6.7.8.

2

MARKET RESEARCH

finance professionals agree that the new FinTech companies will strengthen the competitiveness of existing established players

86%86%

think attitudes are conservative (risk aversion, high financial security etc.)39%39%

think that the mindset of large players towards FinTechs is not collaborative27%27%













3.2.2 Findings





















3.3.1 Insights






3.3.2 Findings





Recommendation # 1



Recommendation # 2





Recommendation # 3







3.2.1 Insights










Banks need to tap into the inner circle of their customer base and truly engage them by building products on the Social, Mobile, Analytic and Cloud model- the SMAC Stack.






13

Figure 3.3 SMAC Stack- The Fifth Wave

13. (Cognizant, 2012)

We are hereBusiness

Productivity

Time

Mainframe

1960-1976

Minicomputer

1976-1992

Distributed PC

1992-2001

Internet PC

2001-2012

SMAC Stock

2012- ?

FinTechs

2012- ?

Catching the 5th wave of corporate IT andcreating a multiplier effect

Source: Cognizant, with editing by FinSurgents

FinTechs positioning themselves on top of banking platforms can help fast track the process of innovation and ensure success for banks for the digitization of payments and increased financial inclusion.













3.2.2 Findings





















3.3.1 Insights






3.3.2 Findings





Recommendation # 1



Recommendation # 2





Recommendation # 3







3.2.1 Insights

























14. (Novoa, 2015) 15. (TechWeekEuropeUK, 2015) 16. (TechWeekEurope UK, 2015)

MARKET RESEARCH

senior executives agree that today’s large financial groups face a long-term threat from new technology

60%60%

think that large players are reluctant in opening up their platforms to smaller players26%26%

14

15

16



3.2.2 Findings





















3.3.1 Insights






3.3.2 Findings





Recommendation # 1



Recommendation # 2





Recommendation # 3







3.2.1 Insights



























3.2.2 Findings










MARKET RESEARCH

senior executives and middle managers respectively agree that FinTechs have an even bigger role to play in emerging markets where they can make disruptive changes and leap frog the gaps while shaping behaviors

80%80%












3.3.1 Insights






3.3.2 Findings


92%92%




Recommendation # 1



Recommendation # 2





Recommendation # 3







3.2.1 Insights



























3.2.2 Findings



















MARKET RESEARCH

senior executives agree that most banks are struggling to keep up with technology

78%78%



3.3.1 Insights






3.3.2 Findings


Challenges faced by banks in realising technology related opportunities

Lack of funds or capital for investment in FinTech opportunities

Lack of relevant and trained resources to carry out the transformation

Lack of analysis and product requirements or process definition

Unfavorable Regulations

Poor customer services

Shifting of core products to digital is seen as intrusion by core/incumbent team

P&L of products with team implementing digitization rather than the product area

Lack of a framework for partnering with FinTechs

Bureaucratic structures and procedures hindering partnerships by delaying decision-making or involving those who don’t understand the

value of partnerships with small tech companies

Perceived threat to internal technical resources of banks

•••••••••

•

MARKET RESEARCH

senior executives agree that it is a good idea for large organizations to create funds to make strategic investments in innovative FinTech companies

89%89%




Recommendation # 1



Recommendation # 2


are of the opinion that access to venture capital is limited33%33%




Recommendation # 3







3.2.1 Insights



























3.2.2 Findings





















3.3.1 Insights




17. (Kaymu, 2015)



3.3.2 Findings


17

1.

2.

3.

4.

5.

6.

7.

Source: FinSurgents Secondary Research

MONET

INNOV8

TPS

AUTOSOFT

ABACUS

TraditionalFinTechs

Karachi

Lahore

Karachi

Lahore

Lahore

Locations

Payments

Branchless Banking, MFS

Payments

Payments, MFS

MFS

Verticals

Table 3.4 Traditional FinTechs


ONELOAD

RED BUFFER

BATWA

PAYLOAD

FINJA

EmergentFinTechs

Lahore

Islamabad

Karachi

Lahore

Lahore

Locations

Payments

Big Data and Analytics

Payments

Payments

Payments

Verticals

Table 3.5 Emergent FinTechs

think that there is a lack of entrepreneurs venturing into the financial technology space

30%30%



think that platforms connecting startups with large firms are absent35%35%


1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

S#

Daraz.pk

Zameen.com

Rozee.pk

Invo8 Limited

PredictifyMe

Vivid Technologies

Interacta

Sportskot

Markhor

AutoGenie

BookMe.pk

MySmacEd

Wifign

Mezaaj

Sheops

Messiah

Forrun

H&O Services

AutoExpert

Cleamry

Artsy

Company

$55 million

$9 million

$6.5 million

$5.4 million

$1.25 million

$350,000

$220,000

£90,000

$120,000

$100,000

Undisclosed

Undisclosed

Undisclosed

Undisclosed

Undisclosed

Undisclosed

Undisclosed

Undisclosed

~$1 million

Undisclosed

Undisclosed

Funding

Table 3.6 Funding for Startups in Pakistan


NEST I/O

TELENOR VELOCITY ACCELERATOR

INVEST2INNOVATE

DOTZERO VENTURES

ARPATECH TECHNOLOGY VENTURES

VOSTOK NEW VENTURES

ARSHAD LATIF

ASIA PACIFIC INTERNET GROUP

BOOST.VC

CDC GROUP

CONRAD LABS

CRESCENT VENTURE INVESTORS

ELEMENT VENTURES

EMERGING MARKETS PROPERTY GROUP

FATIMA VENTURES

J.A. CHOWDARY

JOHN RUSSELL PATRICK

PAK EVENTURES

PITON CAPITAL

ROSEMONT GROUP CAPITAL PARTNERS

SHAFAQ OSAMA

SHEIKH NAHAYAN MUBARAK AL NAHAYAN

SUNBRIDGE GLOBAL VENTURES

TELEFONICA VENTURES

Y COMBINATOR

Name

25

8

5

3

2

2

1

1

1

1

1

1

1

1

1

1

1

1

1

1

1

1

1

1

1

Number ofDeals

Pakistan

Pakistan

Pakistan

Pakistan

Singapore

Sweden

Pakistan

Pakistan

United States

United Kingdom

Pakistan

United Kingdom

United States

Pakistan

Pakistan

Pakistan

United States

Pakistan

United Kingdom

United Kingdom

Pakistan

UAE

United States

United Kingdom

United States

Location

Table 3.7 Overview of Investments in Pakistan 3.3.2 Recommendations

Need for neutral FinTech incubatorsThe solution needed to cater to the challenges mentioned in section 3.3.1 is the creation of FinTech Incubators which make multiple bets in non-overlapping FinTech verticals and are headed by experienced FinTech leaders. Such an incubator will attract investor confidence and interest. Not dependent on the large firms for its survival like any license based vendor, FinTechs in such incubators will be in a better position to bargain partnerships with large players. These incubators will also serve as a platform where FinTechs will connect with large players and investors.

Betting on the right FinTech leader profile Financial services have many aspects which increase their risk beyond that of a traditional technology venture. The Leader Profile for a FinTech company is therefore entirely different from that of a typical startup and contributes directly in mitigating the risk in FinTech investment. For a FinTech, a leader is someone who has had significant experience in the industry with a thorough understanding of the regulatory landscape of the financial sector. A FinTech leader is a well-known face in the industry for whom the industry has opened its doors. They are more likely to attract the right kind of young talent to work on creative concepts. They also understand the language of the industry and act as connectors between young talent and the industry. A FinTech leader is someone who can be brought into the FinTech Incubator to increase the chances of success of FinTech bets.



3.4 FinTechs

This section provides insights into the position that FinTechs occupy in an emerging market and also discusses the connection between FinTechs and emerging business models. It also presents the challenges faced by the FinTechs in Pakistan as discovered from primary market research.

3.4.1 Insights

The Emerging Markets Innovation Stack Many emerging country policy makers have applied the mobile money model in an attempt to enhance financial inclusion. Mobile money provides access to financial services to the unbanked segments by leveraging higher mobile penetration.

The banking industry and mobile money service providers focus on increasing the adoption of their m-wallets to increase financial inclusion because a large population in emerging economies is still unbanked. FinTechs can design specialized products on top of m-wallets to not only address the specific needs of different segments like lending, payroll, supply chain financing, invoice financing for SMEs, insurance, P2P lending and financial management for individuals, but also to increase consumer awareness and transparency through consumer education and product comparison portals. As FinTechs enable the creation of payment rails within emerging markets by enabling retail and online payment acquisition and the aggregation of available payment options, they create the foundational layers of yet another ecosystem – the startups. The lack of connection between buyers and sellers is a characteristic of emerging markets which will be transformed by FinTechs.

With accessible digital payment mechanisms, the availability of inexpensive and easy to acquire financing for small businesses increases, and a whole new breed of startups will emerge, thus boosting the economy even further. During market research, 51% of startups indicated ‘online payments’ as an area where they wanted to collaborate with FinTechs.Figure 3.4 illustrates this Emerging Market Innovation Stack.

The first wave of startup success, which will start by FinTech startups riding on top of the branchless and commercial banking platforms, will eventually take the emerging countries to a new phase where startups will once again enable digital and alternative business models. New breeds of startups will appear in other industries such as healthcare, logistics, agriculture and education and this will help emerging economies enter a new era of development by leveraging technology to alleviate inefficiencies. Thus, the cycle of innovation, triggered by FinTechs, will culminate in other areas as well with similar innovation stacks building up in these industries.

Emerging market FinTechs must be less capital intensive and serve multiple segmentsFinancial technology based startups have lower capital requirements and make scaling easier compared to incumbent models. As discussed previously, the right position of the FinTechs in emerging economies is on top of the incumbent financial services wallet platforms. This fact is further solidified by Omidyar Networks’ findings from its experience which impacts investments and mobile wallets. This suggests that mobile wallets reduce the lifetime cost of providing a consumer with financial accounts by 85%. A lower CAPEX allows FinTechs to break-even faster; the non-linear growth of FinTechs enabled through technology, makes them an interesting investment. FinTechs that focus myopically only on the lower income tiers

are likely to face difficulty in becoming profitable, and the adoption of their products or services could also suffer. The flow of wealth is from the banked, who hold a major portion of the wealth, to the unbanked and a connection between the two segments is a necessary design element. To create this connectivity, therefore, over-the-top FinTech mobile wallets and services are required which can act as a bridge between the two segments. Customers in the upper tiers consist mainly of the tech savvy early adopters who first use a new service and then establish its case for utility and consumer confidence, which eases the adoption by followers and late adopters. The case for utility only trickles down when the tech savvy user at the top can transact with users on the lower layers which is not possible between the two layers unless they are linked together. Moreover, starting from the upper tiers makes the business case more profitable because the offering is the same but it is serving a larger group, rather than myopically focusing on the bottom of the pyramid.

Omidyar Network, from its experience in impact investment, suggests that FinTechs should rely on more than one segment in their business models to be able to earn higher returns by achieving economies of scale and scope. A good example is the case of Safaricom in Kenya, which started from the upper-middle class youth and was mostly used by tech savvy users in its first two years.

MARKET RESEARCH

senior executives disagree that FinTechs are a threat to the established financial services players

59%59%

18. (Omidyar, 2015)

We predict the second coming of the startup ecosystem at the back of the FinTech regulation.

think that platforms connecting investors with startups are absent38%38%

18



FinTech

Digital Business Models and Startup

Unbundled FinTech Service

Consumers

Figure 3.4 The Emerging Markets Innovation Stack




3.4.2 Findings

Unreceptive attitude of large players, difficult regulations and deficient early stage funding cited as the top challenges faced by FinTechs Market research revealed the following challenges as the top challenges faced by small companies attempting to venture into digital finance in Pakistan (see Figure 3.5):

Unwelcoming attitude of incumbent organizations for partnerships A challenging regulatory scenario in the form of unfavorable regulations and uncertaintyDifficulty in modifying consumer behavior Lack of early stage funding Lack of resources to support long product development cycles

With the opening of APIs by MobiCash, Easypaisa and Bank Alfalah for small players, the atmosphere for FinTech- incumbent collaborations in Pakistan is improving. However, the perception of the attitude of large players towards small players has not changed because small companies are unaware of these initiatives. The challenges regarding lack of early stage funding for FinTechs in Pakistan corresponds to a nascent startup ecosystem. One reason for this is the paucity of FinTech startups incubated in Pakistan. Another reason could be the dearth of investor confidence in someone inexperienced to handle the challenges of a FinTech startup. Therefore, a FinTech Leader profile is strongly recommended to lead FinTech ventures. Moreover, FinTechs are small companies that lack the resources to support long product development cycles and hence might not be able to pursue innovative ideas.

19. FinSurgents Industry Interviews

19

1.

2.

3.4.5.

consider that the startup ecosystem is weak36%36%

Factors ranked on a scale of 1 to 5, 5 being the highest.

Source: FinSurgents Primary Research

Figure 3.5 Challenges cited by the FinTech industry

0 3.1 3.2 3.3 3.4 3.5 3.6 3.7

Modifying consumer behavior

Lack of interest from large organizations to partner, collaborate or invest with

small firms

Balancing regulatory compliance with a good solution

Unable to support long product development processes

Access to early stage funding/seed investment

Difficulty in ensuring data security

Difficulty in licensing or access to license holders

Complex or unfavorable regulations

Regulatory uncertainty

Threat to intellectual property

Access of late stage funding for expansion

Lack of mentoring

Difficulty in accessing customer base

Attracting the right talent


GLOSSARY

Glossary

Incubators & Accelerators

Alternative Payment Methods

Angel Investors

Application Programming

Interface (API)

Big Data and Analytics

Blockchain

Cash Economy

Critical Mass

Crowdfunding

Cryptocurrencies

Data Masking

Digital Wallet Payments

Escrow

Financial Inclusion

FinTechs

Hackathons

Incumbents

Organizations that cater to early stage startups and work to refine their business models, provide them with a working space, connections with industry network and

mentorship or early stage funds in return for a small share of the equity of the startup. Startups graduate from incubators and go on to accelerators.

These do not rely on the use of a debit or credit card to make payments and involve online bank transfers, bank based online utility bill payments, mobile carrier bill

payments; cryptocurrencies like bitcoin as well as online payments systems like PayPal.

High net worth individuals investing directly into promising startups in return for the equity share. Angels come from business or entrepreneurial backgrounds and are

suited to startups as they bring with them the experience of past successes and failures, providing coaching and mentoring to the startups with a personal interest in the

success of the business.

It is a system of tools and resources in an operating system, enabling developers to create software applications.

Profiling users on the public, semi-private and behavioral non-financial but relevant data to derive a score, provided to third parties for issuing credit.

It is a data structure that makes it possible to create a digital ledger of transactions and share it among a distributed network of computers. It uses cryptography to allow

each participant on the network to manipulate the ledger in a secure way without the need for a central authority.

An economic system where all financial transactions are carried out using cash.

Refers to the size a company needs to reach, in order to efficiently and competitively participate in the market. This is also the size a company must attain in order to

sustain growth and efficiency.

It is the practice of funding a project or venture by raising many small amounts of money from a large number of people, typically via the Internet.

It is a digital currency in which encryption techniques are used to regulate the generation of units of currency and verify the transfer of funds, operating independently of

a central bank.

It is a method of creating a structurally similar but inauthentic version of an organization's data that can be used for purposes such as software testing and user training.

These include the use of digital wallets to make different kinds of payments; money transfers, bill payments, online payments, etc.

It is a financial instrument held by a third party on behalf of the other two parties in a transaction. The funds are held by the escrow service until it receives the appropriate

written or verbal instructions or until obligations have been fulfilled. Securities, funds, and other assets can be held in escrow.

Defined by the Center for Financial Inclusion as “A state in which all people who can use them have access to a full suite of quality financial services, provided at affordable

prices, in a convenient manner, and with dignity for the clients. Financial services are delivered by a range of providers, most of them private, and reach everyone who can

use them, including disabled, poor, rural, and other excluded populations.”

Small companies and startups obsessed with redefining the financial services value chain through digitization.

A short intensive session where self-selecting teams are given a problem area, data and tools, and are expected to bring their own skills and resources to solve the chosen

challenges

Industry veterans that have been operating in the market for a number of years and have a large presence, for example, banks, MNOs etc.


GLOSSARY

Glossary

Interoperability

Millennials

Minimum Viable Product (MVP)

Mobile Payments

Mobile Wallet (M-Wallet)

Non-Investment Crowdfunding

P2P Lending

Personal Finance/Asset

Management

Picks and Shovels

Predictive Analytics

RegTech

Remittance/Money Transfer

Sandbox

Silo Approach

Special Purpose Vehicle (SPV)

Teledensity

Verisys

GSMA defines it as ‘the ability to transfer money between customer accounts at different mobile money schemes and between accounts at mobile money schemes and

banks’.

Millennials define the generation of people who were born between 1982 and 2004. They came after Generation X.

It is a development technique in which a new product or website is developed with sufficient features to satisfy early adopters. The final, complete set of features is only

designed and developed after considering feedback from the product's initial users.

These include the use of your mobile phone in order to make payments. This involves SMS based payments, direct mobile billing, mobile web payments and Near Field

Communication (NFC) based payments.

It is a way to carry your credit card or debit card information in a digital form on your mobile device. Instead of using your physical plastic card to make purchases, you can

pay with your smartphone, tablet, or smart-watch.

Non-equity, non-lending/debt crowdfunding platforms for products, social causes, and creative projects. Also includes civic crowdfunding platforms and platforms that

give backers a cut of royalty payments from product sales.

It is the practice of lending money to individuals or businesses through online services that match lenders directly with borrowers.

These include tools to track expenses, clear debt, and save money. Also includes tools that address wrongful credit card charges, tools that optimize for credit card

rewards, and insurance comparison tools.

A strategy where investments are made in companies that are providers of necessary equipment for an industry, rather than in the industry's end product.

It is the branch of data mining concerned with the prediction of future probabilities and trends. The central element of predictive analytics is the predictor, a variable that

can be measured for an individual or other entity to predict future behavior.

It is the technology applied to resolve issues regarding regulation within the financial industry. It helps companies to better manage and understand their legal risks as well

as to adhere to their regulatory obligations easily.

Peer-to-peer money transfer platforms allowing consumers to send money abroad conveniently and economically. Mostly concentrated in emerging countries because of

a huge influx of foreign remittance is seen as a big opportunity.

It is a simulated environment in which businesses can test innovative products, services, business models and delivery mechanisms in a live environment without

immediately incurring all the normal regulatory consequences of engaging in the activity in question.

It is a situation where departments or management groups do not share information, goals, tools, priorities and processes with other departments.

Also referred to as a special purpose entity (SPE), is a business entity created to carry out a specific business purpose or activity for the sponsoring firm.

Telephone density or ‘teledensity’ is the number of telephone connections for every hundred individuals living within an area.

An online verification system powered by NADRA and used by financial institutions for biometrically verifying customers.


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