INNOVATION: Sustaining a Competitive Advantage

I have passion for working in the banking industry.

Since May 1^st – July 31^st, 2012, I participated in the NSE investment challenge. I had the opportunity to follow live stock prices for different stocks (am a poor fellow I can’t afford daily signals) offered in the secondary market. I was impressed by various stocks, with a bias in bank stocks. Actually, I was in a self-guided stocks-tour of Kenya’s stocks and came back impressed by the innovation, social impact, and profitability of banking industry. Here is a short case study of Equity bank:

Equity Bank, a global leader in banking the unbanked with creativity and innovation. It’s the fastest growing bank in Kenya. It mainly focused on the un-banked and under-banked markets. At its launch, Equity’s management focused on answering a simple question: How can we lower the consumers’ cost of entry to banking? While the bank now has a broader range of offerings and products, with some strength in SME lending, 60% of new customers are still from the ranks of the unbanked. Now with 6.8 million customers, the bank has cut costs and improved access by offering a low cost, flexible back office system and a focus on mobile phone banking, whose costs are approximately a tenth the cost of a branch-originated transaction. Equity has also developed a low-cost agency system (Equity agents) to serve customers in rural areas. These agents are self-employed individuals (often operating out of their own retail stores) who are trained to provide Equity’s basic banking services (and also to gain more market share), particularly in deposit-taking and small balance lending. Equity bank was among the first banks to adopt mobile money transfer, infact, it came up with an account dubbed the M-Kesho.

Cost-Cutting Strategy

One if Equity’s cost cutting strategies is its employee’s selection. Equity bank employs young, high school graduates as its employees. Infact, its employee average age is 26 years, Generation Y!! Because of the low academic qualifications, these employees are paid little salaries compared to what a university graduate can earn. Through this, the bank actually saves millions of shillings hence increasing its profit.

How profitable are banks? Very! This publicly traded bank (Equity) has returns on equity exceeding 25% and show growth in both loans and earnings per share in excess of 40% annually. It showed a rapid growth through year-end 2011 and is still doing better.

Perhaps the most revolutionary banking product in decades is M-Pesa, transaction banking through simple 2-G mobile phones, which has spread like wildfire in Kenya. Following the introduction of M-Pesa by the mobile provider Safaricom in March 2007, it is now utilized by 14.9 million people, or 65% to 70% of the adult population. Equity easily adopted this technology and went to the extent of partnering with Safaricom to introduce the M-Kesho account.

And this is not the very limited mobile banking service found in the Kenya, but a full range of transaction services, including the purchase of goods and services, remittances, and bill-pay. For M-Pesa customers who link their phone to a bank, a full banking platform is available including interest-bearing savings accounts and credit.

Innovation is not limited to cell phone banking. Seventy percent of Kenya’s 41 million people work in agriculture, typically very small-scale farming. Historically, banks have lent little to this sector because of its high risks, in part due to the highly volatile nature of crop production and prices.

Currently, Equity and other banks are testing the use of index-based crop insurance, a low-cost insurance that will provide farmers a payout should total rainfall come in below some threshold level. This insurance, sometimes combined with forward purchase agreements for farmers’ crops by large financially sound buyers, will substantially reduce risks to borrowers and lenders, permitting an expansion of credit to this large sector.

New developments in mortgage lending are permitting lower income borrowers to build a roof over their heads. Incremental mortgages are structured to safely and soundly meet the repayment abilities of lower income consumers. The poor in much of Africa often build a home over years, first acquiring land, then building one room at a time with much of the labor provided by the owner. Now, some lenders are financing each stage, with each loan maturing in about two years and a new loan being granted only after the first is paid off. For example, a borrower may borrow enough to build the framing and roof, payoff that loan over time and then take out a new loan to finance the construction of outer walls. While it may take some years to finish the home, the financing never becomes overwhelming to the borrower. In addition, Equity Bank announced their partnership with a Kenyan building supply company. Equity Bank will provide micro-mortgages to enable borrowers to purchase building construction materials for as little as US$2,000.

Am very encouraged by THE Equity bank. Unlike banking in much of the other Kenyan banks, Equity bank and a few other financial institutions are designing and introducing products that meet the needs of their customer base. Because so much of that potential customer base has been un- and under-banked to date and because that base is so large, the bank (Equity) is having a huge positive social impact and have tremendous growth potential. It is really impressive to see what banking can be.

Advice to other banks…

Invent or perish!