Should African Neobanks Expand Their Digital Banking Solutions To The CEE Region? #industryopinion

Illustration by Kiril Karov

While in the past we observed a trend of CEE countries exporting fintech to Africa, often with a success rate of 800 000 customers acquired in just 9 months, 2019 marked a shift in the opposite direction. African and in particular Sub-Saharan mobile money providers which amount to more than 144 started breaking into a new market — Central and Eastern Europe.

Mobile money providers belong to neobanks, a type of bank that differs from challengers by their lack of a banking license and physical branches. Currently, the vast majority of their services are mainly bound within Africa and in particular in the 4 main FinTech hubs (Egypt, Kenya, Nigeria, and South Africa). This translates to a relatively small African market and in order to scale neobanks need to find a new niche market.

The CEE startup scene is booming. Approximately €0.7 billion was invested in CEE startups in 2018. Reasons are:

1. The abundance of local talent (about one million CEE developers).
2. High-quality and affordable digital infrastructure with good coverage.
3. Lack of access to conventional banking for the majority of the population in the region.

For example, the majority of Romanians have at least one mobile device, but more than one-third of the population does not have access to conventional banking. This translates to a need for an alternative to traditional banking compared to Western European countries.

The ongoing pandemic is bound to accelerate the process of expansion to CEE where the demand for fully digital services has accelerated. Due to social distancing, we are witnessing a change from cash and POS payments to digital ones. Here are 3 key reasons why CEE should be the preferred region for expansion by African neobanks.

1. Adopting a profitable business model to break into CEE

Ivan, a mobile wallet customer from Bulgaria decided to reduce his exposure to cash during the pandemic back in February 2020. He scanned the apps store for mobile money account providers which will enable him to send money to his relatives in Latvia. Upon installation of the most downloaded wallet, he realized only the paid version is available to customers in Bulgaria. Later he did research and uncovered the freemium plans are still available in other CEE countries. He was disappointed. Not being able to use the app without immediately becoming a premium user meant he cannot achieve his initial goal of making a simple transfer.

Madalin, an active mobile wallet user from Romania who has used the same wallet’s services for more than 3 years is sad to see new taxes being introduced and previous ones increased for the first time since the beginning of the pandemic.

The decision to change the customer offerings in certain CEE markets was only accelerated due to Covid. It showed how some EU neobanks rely on interchange fees, travel, and non-financial products all bundled in the same app as a source of revenue (1). These account for 2 of the 3 business models for profitability that neobanks can adopt:

1. Providing multiple products or services from different industries in one single app (1).
2. Trading (1).

The majority of the leading neobank players who happen to be the first with digital offerings on the European market and now lead the race use these 2 business models. However, they are unprofitable and have led to a low return of investment which continues to hit the end customer with the progress of the pandemic. As a result, they are losing customers.

However, there is a third business model that is more profitable and secures growth and profit in the long term — this is becoming a money lender. Since 2019 the same leaders on the European scene have tried to embrace this new model. However, according to Marc Rubinstein, a former hedge fund analyst “lending is hurting” these neobanks. He points out that losses outweighed the interest they earned from loans in 2019.

However African neobanks who adopt the third business model since their inception have better chances of success in the competitive market. European neobanks who are just starting to embrace the lender business model lack behind in well-established collection processes, risk governance framework, and credit decision engines all intended to keep the risk costs under control (1). This is how Lidya, a Nigerian money lender found success in the Czech Republic and Poland.

African neobanks can thus differentiate themselves and entice new customers through loan offerings which SMEs urgently need during the pandemic. Novel methods for determining creditworthiness are used. Neobanks don’t take collateral for loans. They simply estimate businesses’ current cashflow and look into financial statements. African lenders can thus get a comprehensive financial footprint of a borrower that goes beyond credit history. By having access to a more comprehensive profile of borrowers lenders can offer lower interest rates for loans compared to traditional financial institutions. Lenders can also more accurately determine whether SMEs can pay back their loans and thus reduce the risk. This in exchange allows SMEs to access funds previously unattainable. As a result, SMEs have a preference over the FinTech solutions since they are more balanced and fair in terms of decision making.

2. Gaining a new market

There are 3 reasons for choosing the CEE region. Firstly, while the GDP of the ten CEE countries in total is still comparatively small, it’s per capita growth is impressive — a 114 percent increase in GDP per capita between 1996 and 2017, compared to an increase of just 27 percent in the European Union’s “Big 5” economies. (2). People in these countries are not only spending more, but they are taking this spending online. Given the rise in smartphone adoption globally and in the CEE region the mobile commerce — in-app payments or mobile browser payments is on the rise. Apart from the growth in user base factor, mobile payment adoption is also soaring because of convenience, speed, and safety concerns around handling cash. Merchants are looking to digitalise their payments in a physically safe and technologically secure way, which they can do by shifting the point of sale to a mobile device. (3)

Secondly, CEE is a favorable business environment. Countries in CEE offer low tax rates and competitive labor force costs which might attract young companies seeking success in the region. (4)

Thirdly, adopting the “becoming a lender” business model loan providers in the CEE region could increase the size of loans 4 times, given the GDP per capita difference between the African and CEE market. This means African neobanks can not only lend money to a higher number of small businesses but also increase the size of loans they offer to customers. As a result, profit is bound to go up.

3. Easier expansion across CEE compared to Africa

Let’s compare expansion across CEE countries and African ones. It takes almost a year for African neobanks to expand into CEE. The process includes searching for the right markets — meeting up with potential partners, customers, and regulators — in order to identify the right countries in CEE to expand to. Breaking into the EU also poses obstacles such as licensing of financial services. Europe’s single market is fragmented by language and customer needs. This makes it harder to break into. However the level of market openness is high and the countries in the region share similar levels of digitization, besides their cultural and historic commonalities (2). In contrast to Africa, CEE countries have already implemented common regulations.

For neobanks with African roots eyeing expansion across Africa comes with different hurdles. Firstly, some African countries still do not have specified regulations, where the EU has set a common framework for all its member countries to stick to — the so-called Fintech Action Plan 2.0 (5). Secondly, a different infrastructure needs to be built from scratch per African country which severely hinders expansion. African neobanks are faced with the dilemma of whether the market size is big enough to tackles these challenges. Thirdly, cross borders transfers are more difficult than transfers across CEE countries — there are two currency windows and rates per country.

While expansion in either of these two markets has its challenges, the trend of expansion into CEE that started in 2019 by African neobanks has already shown that success is possible. CATAPULT: Inclusion Africa is the first initiative that aimes to build bridges between Africa and Europe in the world of fintech startups.

Expanding into European markets requires in-depth research of various European regulations such as KYC and tariffs caps (6). Self onboarding journeys need to be taken into account as well. The costs to meet the regulations are costly for small providers.