In a bid to improve financial inclusion, the State Bank of Pakistan (SBP) recently launched Raast, an instant digital payments system, which will be rolled out in three phases by 2022.
Raast will provide necessary back-end infrastructure to payments services providers and should deliver the following objectives: significantly reduced transaction costs; full interoperability between counterparties; improve security; an enhanced user experience.
In this report, we discuss the current state of Pakistan’s digital payments industry, how Raast could bring meaningful improvements, who could be the major beneficiaries, and how investors can access the opportunity.
Pakistan digital payments still at a nascent stage
Currently, digital payments account for only 22% of transactions, and only 4% of transaction value (excluding interbank transactions). However, growth rates are promising; digital payments transactions and transaction value grew by 57% and 117% yoy, respectively, in Q3 2020.
Pakistan has 58mn registered mobile wallet accounts (up 46% yoy), with Easypaisa and Jazzcash major players. This is almost equal to the total number of bank accounts in the country (c60mn). However, only c31mn wallets are active, which represents 22% of the adult population (and the actual number of active mobile wallet users will be even lower, given that some individuals may have multiple mobile wallet accounts).
In addition, most of these wallets are used primarily for domestic person-to-person (P2P) transfers rather than for merchant payments; therefore, the ecosystem is still heavily geared towards cash-based transactions. If adoption takes off, we think Raast could be a game-changer for Pakistan payments landscape.
What is Raast and how is it different?
Raast is a secure, efficient and low-cost digital infrastructure backbone that private companies can use to create front-end platforms, while enjoying interoperability with other organisations.
Currently, there are a few alternative payments gateways in place, like 1Link, which facilitate real-time payments between banks and mobile wallets. However, these systems rely on the infrastructure of incumbent banks themselves, and also charge hefty fees.
Raast will significantly reduce transactional costs and improve the user experience by allowing all payments providers to transact through it. It should also promote innovation by providing a level playing field for all financial service providers.
According to the SBP, the new digital system will be rolled out in three phases by early 2022.
New entrants likely to be the key beneficiaries
Raast will provide a level playing field for new startups, such as SadaPay, which otherwise would face the disadvantage of a limited network of access points (which could take years to build up). Raast will allow them to grow at a much faster pace if they innovate and provide value to their consumers.
Seven mobile wallet operators have so far applied for an electronic money institution (EMI) licence from the SBP. EMI regulations were introduced in 2019 and this development is also helpful for digital payments startups; previously, such companies would need to apply for a banking licence, which are difficult and expensive to obtain.
Our recent study of fintech regulation indicates that capital requirements and deposit guarantee rules are some of the key areas holding back fintech growth in Pakistan.
Raast will also help document the economy
Pakistan’s economy is heavily cash-based and undocumented (currency in circulation is 28% of money supply, one of highest rates in emerging markets). Promoting digital banking will improve financial inclusion and also help document the economy.
Another potential use case for Raast could be digital remittances, with significant amounts currently remitted to Pakistan through informal channels such as Hawala and Hundi.
Implications for listed equity investors
As of now, there are hardly any listed digital payments plays in Pakistan; Systems Limited's (SYS PA) subsidiary EP System is in the process of getting an EMI license.
For banking sector investors, we think banks that are innovating and investing in technology have much greater scope to benefit from this trend; Bank Alfalah (BAFL PA) is our top technology play, it is actively innovating and investing in its mobile platform, Alfa.
We have compared the technology investments of the top Pakistan banks in our earlier note here.
In the long term, though, we think banks are likely to lose the digital payments race to telcos and fintechs, which could eventually hit their growth numbers. However, given the low loans/deposit ratio, this is unlikely to cause much systemic stress.
Pakistan banks are trading at 2021 PE of 7.0 and PB of 0.8x with an estimated ROE of 12.6%. These valuation multiples are at a c15% discount to the past five years median.