Last month, I looked at how the Wirecard saga showed that political risk is not just an EM problem and that fintech investors need to look beyond growth to understand partnership and infrastructure risk. In this final item in the series, I look at how the push to move to electronic payments across the economy, which Covid-19 has accelerated, made the unbanked, including most vulnerable in society, particularly dependent on lightly regulated fintechs that built their businesses on the back of Wirecard’s payments capability. If the move to digital payments is going to reach its logical conclusion and eliminate cash, a more durable solution is needed for the unbanked: central bank digital currencies.
In 2019, my bemusement that Wirecard had managed to continue to grow despite all of the allegations of fraud changed to alarm. In February 2019, the Singapore police raided Wirecard’s offices, adding credence to the growing allegations against the company. At the same time, I realised that, despite growing concerns about the firm, UK local governments were using prepaid cards from Wirecard to provide electronic benefits payments, and fintechs were building their solutions for the unbanked on the back of Wirecard.
1.23mn people in the UK – 2.3% of the adult population – are unbanked. Those people are between a rock and a hard place. Without bank accounts, they cannot access electronic payments upon which much of the modern world depends. In the UK, the workaround has been for the unbanked to take a slip from the bottom of a paper bill to a Post Office or participating corner shop where they pay the bill in cash and the shop or Post Office makes an electronic payment on their behalf. While this just about works for paying a water bill, it leaves the unbanked cut off from a wide range of digital services and dependent on goods from shops they can physically visit, giving them access to a limited range of goods, typically at higher prices than online.
Fintechs have stepped in to help the unbanked, giving them access to a range of prepaid card services that let them participate in the digital economy as though they had a bank account. PockIt, one celebrated example, was established explicitly to help these people, allowing them to avoid what PockIt terms “the banking poverty premium”, estimated at £485 per year for an unbanked person in the UK.
PockIt is on a noble mission, and needed to grow fast to deliver it, so, like many fintechs, it chose to outsource its payments and cards infrastructure to Wirecard. As such, PockIt customers had to wait until the FCA unfroze Wirecard’s UK operations on 30 June, leaving them without access to their money, or the ability to receive and make payments, for four days. Does four days really matter? While I could probably survive with payments for four days, it is a long time for the unbanked, a large proportion of whom are vulnerable people relying on government support. With other firms, like U Account, similarly affected, the UK Department of Work and Pensions had to set up a special team to help welfare beneficiaries affected by Wirecard. I shudder to think what would have happened if the FCA had needed to keep Wirecard’s UK operations frozen, or if the fraud had affected money held with Wirecard in the UK, wiping out the meagre savings of these vulnerable customers.
Covid-19 made the hard place against which the unbanked are pinned even harder, inadvertently exposing the most vulnerable in society to Wirecard. The Salvation Army and other charities distribute UK government support payments to victims of human trafficking and modern slavery. Because these individuals are often in the UK illegally, without any documentation, they have no prospect of accessing the banking system, and support payments are made in cash. The FT has reported that, to protect them from cash as a potential vector for coronavirus, the Salvation Army switched to prepaid cards from B4B Payments, which were operated by … Wirecard, of course. Beneficiaries went hungry during the four days that Wirecard’s UK operations were frozen, unable to buy food without their £35 weekly support payment.
The Wirecard saga highlights the regulatory challenges of the fintech digital payments space. Fintechs have the agility to bring financial services to a wide range of previously unbanked customers, but that risks leaving these customers dependent on one of the least regulated parts of the consumer financial landscape. Even before Covid-19, being unbanked had substantial costs, but now, with a further dwindling role for cash in the economy, the unbanked will be even more disadvantaged.
For digital payments to ultimately deliver on both their original promise to bring a step-change in economic efficiency and their new promise to protect us from currency as a vector for disease, we need a new way to bring the unbanked into the system. Some crypto-bulls have argued that this means that digital payments should move to utilising cryptocurrencies that allow the consumers to hold an asset rather than a claim on a payments provider. However, pushing vulnerable customers from lightly regulated fintechs into volatile cryptocurrencies does not seem to make sense. Nor does it make sense to force traditional banks to accept the unbanked as customers, when more than one-quarter of the newly banked are net losers in their first year of banking, incurring penalty charges in excess of the benefits they gain by having a bank account. What’s needed is something that gives the unbanked the certainty, simplicity and ease of budgeting that they have with currency, but also lets them access digital payments. They don’t necessarily need bank accounts – rather they need currency as today, just digital.
In due course, Wirecard’s failure may be yet another step on the road to central bank digital currencies. Central bank digital currencies would allow the unbanked to directly hold electronic cash, removing much of the pain of being unbanked and allowing the post-Covid-19 transition away from cash to continue. Notably, Andrew Bailey, Governor of the Bank of England, has recently acknowledged that the Bank is actively debating the creation of a central bank digital currency, building on the existing international central bank digital currency working group.
Central bank digital currency will help save the unbanked from future Wirecard-style problems, but its implications are much wider: If interest rates are low, and digital currency is as convenient to hold as bank balances, will savers and companies withdraw their savings from the banking system? How will banks innovate to retain customers? How will credit intermediation work in a digital currency world? I’ll be expanding my work on this topic from our 2018 Global Themes in my forthcoming book, which argues that blockchain technology will have the greatest impact in developing countries.