In Kenya, new banking technology is paying dividends

The growing use of modern means of payment has dramatically reduced the use of cash in preference for the use of bank balances. But as we marvel at the ease with which money moves around electronically, it is easy to overlook the continuing need in many instances for an interface between cash and deposits. That interface may be symbolized by a bank teller window.  You might receive your weekly or monthly wage as a direct deposit to your bank account (an ACH transfer from your employer’s account to yours) and you might make many of your payments by transferring those balances to others, but the system would not work (at least not yet) without the ability to deposit and withdraw cash.

For that you need the old-fashioned teller window through which cash is paid in or out. The ubiquitous ATM machines are a modern version of the teller window and testify to the continued use of cash and thus for the need for means to deposit it in or withdraw it from a bank. Conceptually, the system could become cashless, with all payments made by transferring bank balances from one account to another, but this not will not happen in our lifetime.

Mobile phones are the most dramatic and interesting recent innovation in payment technology. They provide an extremely low-cost technology for issuing and executing payment messages. One of the most interesting innovations is the extension of the teller window—the cash in cash out point—from your bank or an ATM machine to an authorized agent of the provider of the mobile phone payment service.

In Kenya, for example, the dominant provider of mobile phone services is the largest mobile phone company, Safaricom. Their mobile phone payment service is called M-Pesa. M-Pesa provides subscribers with texting software on their mobile phones with easy steps for crediting cash to an account, for transferring it to other M-Pesa account holders, and for receiving transfers from other account holders (e.g., your wife or your employer). There are more M-Pesa accounts in Kenya than bank accounts. The cash in/cash out (teller window) function is performed by authorized M-Pesa agents. Initially, these agents were generally mobile phone airtime vendors (phone cards) that can be found on many street corners or in small kiosks around Kenyan cities and towns. Now, many merchants and even banks function as Agents. Cash can be collected from or deposited into the system through these Agents.

If you work in the city and your family lives in a distant village, your transmission of your wages to your family via your mobile phone does not, obviously, actually send cash electronically. Like a check, a mobile phone payment is simply an instruction—a text message—that authorizes the recipient to receive cash from a nearby office/Agent. The need to manage the stock of cash (availability, safekeeping, note quality, etc.) has shifted in part from individuals — city workers used to take the bus home on weekends to deliver cash to their families — and banks to mobile phone payment Agents.

The Agents are responsible for keeping enough cash on hand for payouts and for safekeeping cash received for deposits. A large part of the cash paid out by a bank or Agent in a region stays and circulates within the region. Thus, to some extent, cash paid in or paid out by Agents balances. Any net flow of cash to or from the village must be organized by the Agents and physically transported. If a bank office is available, cash shipments are most likely to be organized via the bank.

This new payment technology is having a material, positive impact on life in Kenya, especially for the low income population. It has implications for monetary policy as well. The use of cash has fallen rapidly. In less than three years, the share of central bank money (currency held by the non bank public and central bank money held by banks—cash in bank vaults and bank clearing deposits with the central bank) held as cash by the public fell from 64% to 56%, a 12.5% drop. This shift of cash to bank deposits allows the banking system to create more deposits (also a part of the country’s money supply) from the same amount of central bank money (so-called “reserve” or “base” money). To prevent this very positive development in payment technology from being inflationary, the central bank must slow the rate at which it creates central bank money.

The history of money has been a long series of innovations that lower the cost of making payments. The history of the behavior of money’s value has been more uneven. Technological innovations in making payments pose challenges to central banks’ effort to preserve the value of the money they issue, but they can meet these challenges if they pay proper attention.

The Central Bank of Kenya has adopted an enlightened supervisory attitude of putting primary responsibility for the development of services and their safeguards with the service providers, but has insisted that new uses be tested in a gradual, careful, and market-driven process. Kenya has become a leader in an exciting new technology primarily of benefit to the poor and middle class.