kate ross goldman leads the FinTech program at the Milken Institute’s Center for Financial Markets.
Illustrations by jd king.
Published July 26, 2021
Millions of people have migrated across national borders over the past few decades in search of better jobs. And many of these migrants regularly send money home. Cross-border money transfers from diaspora populations, often referred to as remittances, loom large in the living standards of many low-income economies. Remittances to some countries, as scattered and diverse as El Salvador, Tajikistan and Tonga, total more than one-quarter of GDP. The numbers exceed 10 percent in dozens more.
But as anyone who has wired money to a college student who overspent their allowance or to a relative stranded in a distant city knows, the process can be time-consuming and very expensive. The good news is that greater competition, combined with advances in digital technology that leverage the internet and smartphones, has offered remittance solutions with lower fees and faster payment processing.
For example, Xoom, a PayPal service that bills itself as a low-fee leader, on average charged a bit less than 4 percent in 2015 — which doesn’t seem all that small until you factor in the reality that the sums transferred often amount to just a few hundred dollars. The global average fee in that same year, by the way, was about 7.4 percent. And with over $550 billion in remittances being sent to lowand moderate-income countries in 2019 (the last year before Covid-19 slashed transfers), the dimes and dollars really add up.
Covid-19 isolation restrictions have limited in-person services. The catch is that the ubiquity and ease of digital transfer doesn’t eliminate the need to provide secure identification at some point in the transaction chain.
The bad news is that sub-Saharan Africa, a global region that heavily relies on remittances, has enjoyed little of the benefit of technical advancements in payment systems. According to the World Bank, transfers to the region incurred an average of 8.9 percent in fees in 2019, compared to the global average of 6.8 percent.
This disparity is largely the fault of the usual suspects: little competition, exceptionally high overhead costs — and, most important in this context, formidable regulatory compliance hurdles. Anti-money-laundering regulations bar some 500 million people from sub-Saharan Africa who have no legal proof of identity from using formal remittance channels.
There are alternatives, ranging from carrying cash home on visits to trusting informal transfer networks to piggybacking on the remittances of folks who do have adequate IDs. But, needless to say, they are expensive and insecure. The key to bringing the benefits of low-cost, secure, and efficient digital remittances to sub-Saharan Africa lies in establishing nationally recognized digital identity systems.
Two primary models of digital remittance services are broadly employed. The first is a mobile money transfer service, which capitalizes on the ubiquity of mobile phones to provide cross-border transfers. M-Pesa, for example, allows individuals to access a range of financial services through their phones without the need for bank accounts. Users can swap their cash for digital money by visiting an M-Pesa agent. M-Pesa — “pesa” meaning money in Swahili — was launched by Vodafone’s Kenyan Safaricom mobile operator in 2007 as a tool to exchange small payments by text message. With 42 million customers, the platform is now functioning in seven countries and has ambitious expansion plans in terms of both scale and scope. Critically, in this context, it has expanded its range of services to include international transfers.
The second model is from specialized, digitally based providers such as WorldRemit and Wise. Customers can easily compare costs from a digital interface without traveling to a traditional bank or even one of the thousands of part-time M-Pesa agents to be found in rural Africa.
Both digital models have grown in popularity over the last year, as Covid-19 isolation restrictions have limited in-person services even for those living near financial agents. The big catch is that the ubiquity and ease of digital transfer doesn’t eliminate the need to provide secure identification at some point in the transaction chain.
Some regulators in Africa have relaxed policies to allow wider access to mobile phones and digital service providers, presumably on the assumption that the benefits of broader access are worth the risks. Notably, Ghana’s government has relaxed regulations that initially required customers to show their IDs at a mobile carrier’s physical location to purchase SIM cards. But that is only one step in the transfer process. A secure digital form of ID is a must.
The Cost of Compliance
All remittance service providers, whether they are traditional banks or digital innovators, are obligated to satisfy national and international anti-money laundering policies that deter illicit financial transfer in aid of terrorism, organized crime or tax evasion. Failure to follow the regulations subjects financial intermediaries to punishing fines, or even loss of access to the global payment clearing systems. Under the AML umbrella are the Know- Your-Customer (KYC) policies that oblige financial service providers to identify their customers. To do this, remittance service providers must verify a customer’s identity during initial interactions and in subsequent due-diligence checks.
Due to the nature of KYC laws, having a valid form of identification (like a driver’s license or passport) is required to use formal remittance channels. Policy reform should not aim to weaken ID standards — the goals of KYC laws are important — but to make compliance practical for more people. In Africa, implementing a digital identity system could bridge the gap between those excluded from the traditional financial system — by virtue of cost, geography or circumstance — and the innovators working to bring financial technology to them.
The Case for Digital Identity
In the physical world, a passport or driver’s license is usually adequate ID in daily transactions. Africa’s digital economy is proliferating, in large part because a trip to the bank is not practical for most daily financial transactions. Brick-and-mortar banking has been further deprioritized during the pandemic.
Digital IDs allow people to electronically authenticate themselves, enabling users to send money quickly and securely on their preferred remittance platforms. Digital IDs can also help regulators track cross-border payments and prevent money laundering as more transactions are occurring under their purview. Finally, with the potential for 500 million new marketplace entrants, digital IDs present a real growth opportunity for fintechs, which have the potential to turbocharge economic growth in places where traditional financial institutions have virtually no reach.
A good demonstration of how governments can effectively leverage technology to improve financial systems comes from one of the world’s most advanced economies: Norway’s digital ID, called BankID. While designed with banks in mind, BankID can be used by all organizations and enterprises looking for secure and simple identification online. The 4 million Norwegians using the system can thus verify their identity or sign documents across myriad platforms, increasing convenience and sharply cutting transaction costs.
Africa is not alone in seeking to catch up: India has also struggled with huge numbers who could not easily prove their identities. To address this, India’s government developed Aadhaar, a 12-digit method of identifying citizens that is used for activities ranging from receiving government benefits to paying taxes. NPR reported that, in less than a decade, India has collected the fingerprints, photos and iris scans of some 1.2 billion people.
Digital IDs have already been introduced to solve a host of problems in Africa. Botswana and Nigeria have seen impressive cost savings using biometric identification in pensions and social grant programs.
New Delhi’s primary goal was reducing tax evasion, a very serious problem in India. But Aadhaar has experienced major difficulties; it is widely criticized for technical malfunctions and data security breaches. Still, a World Bank report estimates Aadhaar could help lower initial onboarding costs for processing new customers for financial institutions from 1,500 rupees ($23) to just 10 rupees.
Establishing a similar digital ID system in Africa is not without challenges. But the growing pains of Aadhaar should not deter African regulators from modernization. On the contrary, its lessons can help inform a rollout with fewer glitches. A successful framework would include solid data privacy protections and safeguards against government overreach. With more countries in Africa establishing their own data privacy frameworks — 13 countries in the past five years have embarked on the process — the task of building digital IDs is increasingly within reach.
Digital IDs have already been introduced to solve a host of problems in Africa. Botswana and Nigeria have seen impressive cost savings using biometric identification in pensions and social grant programs. The technology behind digital IDs has also grown in maturity since digital IDs were introduced elsewhere — remember, Aadhaar is already a decade old. And while creating and diffusing a digital ID that serves a wide variety of functions is no small-dollar project, there has also been an outpouring of financial support from organizations ranging from the World Bank’s ID4Africa project to the Omidyar Network’s donation to the United Nations Economic Commission for Africa.
A Glimmer at the End of the Tunnel
The growth of international remittances is both a troubling sign of global economic dislocation and a lifeline for many low- and middle- income countries. Digital and traditional remittance channels have seen vast improvements — largely thanks to technology — in recent years. Barriers to entry have prevented millions across Africa from realizing these remittance improvements. While the proximate cause of the problem is security and cost in international transactions, a harmonized digital identity approach could bolster broader financial infrastructure and greatly improve access to Africa’s growing digital economy.