S&P Global Ratings believes financial technology (fintech) in the Middle East and Africa (MEA) will continue to slowly expand and therefore constitute a limited threat to the region's well-established financial institutions in the foreseeable future. The creation of a propitious fintech ecosystem is still a work in progress in most regional countries and cities. The most advanced are Dubai (through the Fintech Hive in the Dubai International Financial Center or DIFC) and Bahrain (through Fintech Bay).

We are of the view that money transfer, payment services, and compliance with regulations are the main sectors that are bound to be disrupted by fintech in the next few years. We also believe fintech offers other opportunities for the region's banks, such as financial penetration in less developed African countries and the use of blockchain for capital market issuance of conventional and Islamic securities. However, several prerequisites are necessary for that to happen.

We do not expect fintech alone to have a significant bearing on our ratings on Middle Eastern and African banks in the next two years. Instead, we foresee more cooperation between fintech firms and banks, and strong regulatory protection given the significant role of banks in financing regional economies.

The Key Factors Of Successful Fintech Ecosystems

In our view, the key factors contributing to a successful fintech ecosystem include:

Human capital

This can take the form of a presence of a large pool of technology-savvy people with good knowledge of the financial industry or a strong education system that contributes to the creation of such a talent pool. This also requires the presence of firms and individuals tasked with providing advisory services and coaching opportunities for this workforce.

Regulation

Regulators that allow fintech companies to operate in a light regulatory environment under almost real-time conditions so that they can test their ideas and ensure their viability. Their role is both defensive, protecting the consumer and overall financial system, and offensive, by helping fintech companies spread their wings in a controlled environment. Clarity of the regulatory requirements during the test phase and at the launch of fintech companies is essential. For Islamic fintech ecosystems, this also includes a dimension related to Sharia requirements and compliance.

Financial capital

During their design and launch phases, fintech companies burn cash and require access to a significant amount of financial resources. Access to funding through dedicated funds, foreign direct investments, a pool of business angels, or government funds is necessary to ensure the effective support of fintech companies.

Physical infrastructure

This ranges from the access to information and communication technologies to coworking spaces.

Demand

Demand can come from either established financial institutions or end users. It can also be created by an innovative fintech launching a new service or way of doing business that was not envisaged in the past. Demand requires a minimum of financial literacy to understand the services a fintech can offer.

GCC Countries Are The Most Ready For Fintech

• To compare the readiness of MEA countries for fintech, we looked at qualitative and quantitative information in three subregions:
• North Africa (Mauritania, Morocco, Algeria, Tunisia, Libya, and Egypt);
• The Gulf Cooperation Council (GCC) countries (Bahrain, Oman, Kuwait, Qatar, Saudi Arabia, and the United Arab Emirates); and,
• Sub-Saharan Africa (remaining African countries with available data).

Human capital:

We looked at the World Bank Human Capital Index as a proxy for the availability and the quality of human capital for these regions. We also used the 12th pillar of the World Economic Forum's Global Competitiveness Index, which focuses on innovation (see chart 1).

Regulation

We used our assessment of institutional framework that we conduct as part of our banking industry country risk assessment. The institutional framework looks at, among other factors, the quality of regulation and regulator's track record. Within our sample, the GCC countries, South Africa, and Morocco stand out as benefitting from relatively stronger institutional frameworks.

Financial capital

Our view of the availability of capital is based on indicators such as the capitalization of the banking systems. We also use the Venture Capital Availability score of the Global Competitiveness Index (see chart 2).

Physical infrastructure

We looked at two indicators. One is the percentage of the local population with access to the internet and the other is the ease of starting a business, which is one pillar of the World Bank's Ease of Doing Business Index (see chart 3).

Demand

We used indicators such as banking penetration (the percentage of adults with a bank account), as well as the percentage of the population that has a mobile account, used the internet to access a financial service, or received a digital payment (see chart 4).

Chart 1

Chart 2

Chart 3

Chart 4

These indicators show that GCC countries appear to be the most ready for fintech adoption in MEA. In our view, the key driver is demand--the preference by clients for digital banking. Moreover, these countries enjoy the ready availability of financial capital. Their banking systems are strongly capitalized--we estimate the average risk-adjusted capital for rated banks was at close to 12% at year-end 2018. In addition, they are typically net exporters of capital, and some of their governments set aside funds to push forward the fintech agenda. For example, the DIFC in 2017 launched a $100 million fund to help establish, grow, and upscale start-up and growth stage fintech firms. Similarly, Bahrain Development Bank and the Economic Development Board of Bahrain have launched two separate funds of $100 million each to support fintech. We believe that the willingness of and actions by regulators and the markets to innovate will be key to maintaining high-quality services by efficient and robust servicers.

The fintech ecosystems in North Africa and Sub-Saharan Africa appear less friendly than those in the GCC but for different reasons. Some Sub-Saharan countries appear more advanced when it comes to the development of mobile banking solutions and payments (for example, Kenya). The demand for such services appears more developed in Sub-Saharan Africa than in North Africa, where the use of the internet for financial services transactions is lower. At the same time, North African countries appear to benefit from better quality infrastructure and a higher abundance of human capital. Both regions are in similar situations when it comes to regulation or the availability of financial resources to push forward the fintech agenda. With few exceptions, we view regulators in these regions more as reactive rather than proactive. Finally, capital is scarce on both sides of the African Sahara. As part of their push for higher financial inclusion, multilaterals could play a role in providing fintech firms or authorities with some financial support.

What Business Lines Will Be Disrupted And How?

We believe that fintech could help the financial industry in MEA in at least three ways:

• Ease, transaction speed, and reach of financial services;
• Security and traceability of transactions; and,
• Improved governance.

Ease, transaction speed, and reach of financial services

This is particularly true for payment services, money transfers, and crowdfunding. GCC banks, for example, generate about one-quarter of their revenue from non-interest-dependent sources. Remittances are the low-hanging fruit. At year-end 2017, expatriates in the GCC sent about $120 billion back home. At the same time, African countries received an estimated $86.3 billion of remittances--about 4% of their GDP at year-end 2018. The cost of sending this money is still significant, consisting of both a nominal fee and, more importantly, a significant margin on the exchange rate. It also takes time, especially if the transfer is made to another emerging market. A fintech that focuses on this niche market with the objective of increasing the speed and reducing the cost of the transaction will certainly attract clients.

Chart 5

We note that there are a couple of companies in the region that are already focused on providing these kinds of services in the DIFC Fintech Hive. Verify Payments, for example, is working on instant and low-cost bank transfers across the GCC. Amplified Payment Systems Ltd. aims at connecting banks, telecommunication companies, and businesses to their customers to drive adoption of digital financial services through messaging.

Crowdfunding is another area that can disrupt the core businesses of financial institutions. Although we think that crowdfunding will not be a viable substitute for corporate lending, as most of it in MEA is based on relationships, it can open new avenues for financing small-ticket projects. The key factor for success would be adequate protection of stakeholders. Mobile banking and payments is another area where fintech can complement the offering of more established financial institutions, especially when they lack physical contact with their customers, as in some rural areas of Africa, where banks are absent, but customers have access to mobile services. On the African continent, Kenya is one of the leaders in terms of mobile services payments systems, for example. Its success story can be replicated in other MEA countries as long as there is access to mobile communications.

Security and traceability of transactions

This is also easily achieved for fintech companies. Problems related to the security of information and financial transactions are gaining significant importance. The use of blockchain technology could help reduce exposure to risks related to transaction security or identity theft. It could also help the structuring of bonds or sukuk--and the resolution of sukuk in case of need through smart contracts--and trade finance transactions. This will take time, though, as blockchain technology isn't ready for large-scale adoption.

Improved governance

We believe regulatory technology could reduce risk in the financial services industry through more robust tools for achieving compliance with regulations. It could help minimize the reputational risk related to a potential breach of regulation. For Islamic financial institutions, regtech could also help achieving stronger Sharia compliance, assuming globally agreed standards are in place. It could also help free up Sharia scholars' time so they can focus on innovation. There are few examples in the Fintech Hive: Blinking.id, Verismart, and Amani Technologies Ltd. aim at improving and automating know-your-customer processes, with some using blockchain to that end.

Fintech Will Have A Minimal Effect On MEA Bank Ratings For Now

We do not expect fintech alone to have a significant bearing on our banks ratings in MEA in the next two years. We expect partnerships between banks and fintechs to grow and strengthen. We see more and more banks embracing opportunities to onboard convenient solutions from external providers to enhance their value chain. Banks in the region generally enjoy a relatively strong entrenchment in their local markets in the absence of other more viable sources of financing. Given the importance of this role, we expect regulators in most of these countries to continue protecting the financial stability of their banking system from disruption that may reduce the quality of banking services or result in weaker, more vulnerable, banking systems. However, at the same time, we expect fintech innovation to be promoted through regulatory easing, such as sandbox approaches.

Related Research

• GCC Islamic Banks Will Likely Stay Resilient In 2019-2020, May 6, 2019
• Oil Prices Will Help Shape Sukuk Markets' Performance In 2019, Jan. 15, 2019
• The Future Of Banking: Blockchain May Be The Sukuk Industry's Missing Link, Oct. 24, 2018
• The Future Of Banking: Islamic Finance Needs Standardization And FinTech To Boost Growth, April 16, 2018
• The Future Of Banking: Cryptocurrencies Will Need Some Rules To Change The Game, Feb. 19, 2018
• The Future Of Banking: Could Fintech Disrupt Gulf Cooperation Council Banks' Business Models?, Oct. 16, 2017